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Edited Transcript of FRAN earnings conference call or presentation 11-Sep-18 12:30pm GMT

Q2 2018 Francesca's Holdings Corp Earnings Call

HOUSTON Sep 17, 2018 (Thomson StreetEvents) -- Edited Transcript of Francesca's Holdings Corp earnings conference call or presentation Tuesday, September 11, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kelly M. Dilts

Francesca's Holdings Corporation - Executive VP & CFO

* Steven Paul Lawrence

Francesca's Holdings Corporation - President, CEO & Director

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Conference Call Participants

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* Dylan Douglas Carden

William Blair & Company L.L.C., Research Division - Analyst

* Janet Joseph Kloppenburg

JJK Research Associates, Inc. - President

* Steven Louis Marotta

CL King & Associates, Inc., Research Division - Senior VP of Equity Research & Senior Research Analyst

* Susan Kay Anderson

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Francesca's Holdings Corporation Second Quarter 2018 Earnings Call. Today's call is being recorded.

At this time, I'd like to turn the call over to Kelly Dilts. Please go ahead.

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Kelly M. Dilts, Francesca's Holdings Corporation - Executive VP & CFO [2]

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Thanks, Espie, and good morning, everyone. We appreciate your participation this morning in francesca's second quarter fiscal year 2018 conference call. Earlier this morning, we issued a press release outlining our financial and operating results for the second quarter ended August 4, 2018.

Please note, the following discussion includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts included in today's discussion that address activities, events or developments that the company expects, believes, targets or anticipates will or may occur in the future, are forward-looking statements. The company's actual results may differ materially from those projected in the forward-looking statements as a result of certain risks or other factors, including those risk factors set forth in the company's Form 10-K and quarterly reports on Form 10-Q filed with the Securities and Exchange Commission. All such statements speak only as of the date made and, except as required by law, the company undertakes no obligation to update or revise any forward-looking statement, whether as result of new information, future event or otherwise.

As usual, a replay of today's conference call will be posted on our website.

We'll begin today's call with comments from our President and CEO, Steve Lawrence. Steve?

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [3]

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Thanks, Kelly. Good morning, everyone, and welcome to our second quarter earnings call. During our time today, Kelly and I will give you some color around our second quarter performance, along with how we see the back half of the year playing out.

Overall sales for the second quarter did not meet our expectations. Our biggest challenge in the quarter was weakness in brick-and-mortar traffic that averaged down low double digits and led to a 13% comp sales decline for the quarter.

While we continue to manage through the choppy top line sales trends, we've been focused on maintaining disciplined cost control measures. These efforts helped us come in just below the low end of our EPS guidance of $0.01.

We're also pleased that despite a challenging top line sales, we ended the quarter with clean inventories at down 13% on a per-boutique basis.

Beneath the surface, the content is much more current and forward-facing than last year, with clearance representing roughly 15% of our inventory at the end of the quarter.

Despite the disappointing sales performance, we have several takeaways that give us confidence we're moving in the right direction.

First, our e-commerce business continues to grow at a double-digit rate, as we continue to advance our omnichannel capabilities. Our plan going forward is to push even harder on the dot-com front. And to help us with this, we've recently engaged with a consulting group to help us build and execute an acceleration plan for our e-commerce business. We will share more details, as this plan starts to crystallize.

Second, as you know, we've been on a journey to upgrade and improve our assortments, while also shifting our edit point back to our core 18- to 35-year-old demographic. We've been focusing on conversion as a key metric to indicate our guest acceptance of the new assortment. While our boutique's conversion rate averaged down 8% for second quarter, we saw a sequential improvement each month. And as we got into the middle of August, we saw conversion flatten out.

Third, we're also seeing our AUR stabilize and benefit from better full price selling in the new elevated merchandise. The team has worked hard to ensure that our quality has been raised and the assortments have an amazing perceived value.

What is clear from the second quarter results is that it's taking us longer than anticipated to turn the corner and to get our core guest to reengage and shop with us with the same frequency that she has in the past. While we believe the merchandise assortments we have on the floor is a dramatic improvement over our offering last year at this time, we're not sitting still. The team is constantly evaluating on what was working and what is not, while moving quickly to react to the selling and making adjustments to our fall and holiday assortments accordingly.

While we are seeing improvement in many of our key metrics, our slowdown in traffic is indicating to us that it will take time to regain her trust and win her back. As a result, we're lowering our sales guidance for the back of the year and are now expecting comps to come in flat to down 5%. With the lower sales volume, we're now forecasting EPS to come in for the year at $0.15 to $0.25. I will stress that the team is working hard to offset the deleveraging effect at reducing our sales guidance by controlling expenses, while also protecting strategic investments that will help us turn the corner and improve our performance.

We're also controlling inventories and managing to a lower sales forecast to ensure that we don't get into an overbought position.

We put in place a lot of new capabilities over the last 18 months. At this point, we are in the very early innings in many of these initiatives taking root and are just now starting to see some of the benefits. I'd like to highlight a couple of the bigger changes we've made.

As I mentioned earlier, we've upgraded and refined our assortments by moving our edit point back to our core demographic of 18 to 35 years old. This has translated into our assortments being on trend versus being on the edge off the trend curve.

At the same time, we're also raising the level of quality, which is translating into an improved value proposition. Additionally, the team is reinventing many of our legacy categories to help give us a unique and differentiated point of view. A great example of this is our updated gift assortment that we're rolling out for holiday. We're introducing new categories. We're also focusing on special and unique finds that will surprise and delight, while moving away from more commoditized items and categories. We believe this should be a key business driver for us heading into holiday.

In terms of the mechanics of how we buy and assort, we've reengineered our buying process and are back to executing our broad and shallow approach, while thoughtfully curating assortments that enable her to create complete looks. This is helping us improve both conversion and units per transaction.

The team has also put in place much more rigorous planning and allocation disciplines, the result of the better balanced, just-in-time receipt flow that much more closely ties back to our boutique capacities. The end result is boutiques are getting new receipt virtually every day, and these goods are almost immediately go into the sales floor versus sitting in a back stockroom for some period of time.

One thing that is clear from our selling is that our guest has a voracious appetite for newness, and we believe delivering a steady and consistent flow of newness is going to be a key ingredient in our success going forward.

We're pleased that our inventories are well controlled, and our plan is to not let this discipline slip. As I stated earlier, inventory was down 13% versus last year on a per-boutique basis at the end of Q2, and we expect it to be down high single digits at the end of Q3.

We have elevated and repositioned our marketing message to have a better blend of inspirational style at a compelling value. Historically, our marketing spend has been well below industry average, and we recognize an investment in marketing will be key in winning back our customer and keeping her engaged with the brand. While we're focused on expense controls, marketing is the one area where we plan to continue to invest. Our plan is to increase our marketing spend by roughly 20% during the back half of the year. We'll focus this increased spend into those muscle-in time periods in the calendar, most notably Thanksgiving and Cyber Week, along with the ramp-up to Christmas.

Our new POS system that we implemented last year has enabled us to roll out 2 new omnichannel capabilities this year. Our teams and guests have rapidly adopted our buy in boutiques with the home capabilities. And in a short period of time, these orders have grown to represent over 20% of our dot-com business. At the same time, over 10% of our dot-com customers are choosing to have their orders shipped to a boutique. As this volume continues to grow, we should see an even greater positive impact on store traffic.

We have piloted and rolled out a store remodel program that we're utilizing a refreshed 80 to 85 older vintage boutiques. This is the same format we're using in all of the new boutique openings. And at this point, we should head into holiday with over 15% of our boutiques in this new format. We continue to see this for us consistently drive better results in boutiques than the old format.

Finally, we just rolled out our new franREWARDS loyalty program to all boutiques during late second quarter. I'm pleased to say that we've grown this file to over 2.1 million guests in a very short period of time. Going forward, franREWARDS gives us a new powerful marketing tool that will allow us to drive sales by engaging with our loyalists in a deeper way and on a much more consistent basis. As a matter of fact, we're running our first free gift promotion in the next couple of weeks, and we're excited to see our guests' reaction to it.

To reiterate, we are on a journey to transform our business. Our strategy is to embrace the best elements on what made this company great when we were initially founded, but interpreting and executing them in a way that is relevant for today's rapidly changing retail landscape. While it is taking us longer than anticipated to redeem momentum in the business, we believe that we're on the right path and that we're at the very early stages of seeing these strategies unfold and drive improvements. Our plan is to practically manage the business and call audibles as we go, but to stay focused on this journey of transformation and get some of the initiatives we put in place a chance to play out.

Now I'd like to turn it over to Kelly to walk through a more detailed breakdown of our second quarter results as well as our updated guidance for the remainder of the year. Kelly?

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Kelly M. Dilts, Francesca's Holdings Corporation - Executive VP & CFO [4]

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Thanks, Steve. I'll begin with a review of our second quarter 2018 financial results, followed by a discussion of our 2018 third quarter and revised full year guidance.

Net sales for the second quarter decreased 6% to $113 million compared to $119.7 million in the same quarter last year. These results are below the guidance we gave on our last call, as some of the encouraging results we saw in May did not build as expected through the rest of the quarter.

Comparable sales declined 13%, primarily as a result of the decline in boutique traffic as well as a lower conversion rate.

As Steve mentioned, our traffic trends were well below our expectations and the launch of our new loyalty program, and our new floor set did not generate the expected lift in boutique traffic. While the conversion rate was down year-over-year, it improved sequentially from month to month throughout the second quarter and into August, which indicates to us our newer deliveries are resonating with our guests.

E-commerce sales remained strong and exceeded our expectations with the strong traffic and conversion.

Looking at average ticket, both average unit retail and unit per transaction increased during the quarter. We saw a healthy increase in AUR from first quarter to second, mostly due to the increased penetration of regular inventory sales versus clearance. Average transaction value had a 500 basis point improvement from first quarter to second quarter and increased compared to the prior year.

By merchandise category, all categories showed sequential improvement versus the first quarter, except for gifts and shoes. Accessories comped positively with strong performances in scarf and hair accessories. In jewelry, we capitalized on the strong trend in statement earrings. However, this was offset by declines in necklaces and bracelets. In gift, beauty was strong, but was offset by weakness in other category. That said, we are working on our gift category, and we believe we are curating a compelling assortment for the holiday season. In clothing, bottom, driven primarily by skirt, comped positively. However, dresses and tops remained weak, although tops did improve from first quarter.

Gross margin decreased 730 basis points to 39%; 400 basis points was due to occupancy deleverage. Merchandise margins declined 330 basis points due to higher markdowns, as we continue to execute on our end season clearance strategy. Additionally, we took marked out-of-stock charges in order to allow the focus to be on our new floor set.

Second quarter SG&A expenses decreased $300,000 or approximately 1% compared to the prior year quarter. This decrease was primarily due to $1.6 million of lower performance-based incentive compensation, partially offset by an increase of $900,000 in corporate payroll to support those e-commerce operations as well as infrastructure and strategic investments.

Additionally, we had an increase of $300,000 in marketing to support the launch of the franREWARDS loyalty program.

It should also be noted that the selling expenses were well managed and came in flat on a dollar basis to last year, despite the increase in the number of boutiques.

Our effective tax rate for second quarter was 44.6% compared to 38.7% last year due to additional tax expense related to the vesting of certain stock-based awards.

Diluted earnings per share for the second quarter was $0.01 compared to $0.20 last year.

Turning to the balance sheet. We ended the second quarter with $23.4 million in cash compared to $33.3 million at the end of second quarter last year.

As noted earlier, inventory decreased 13% on a per-boutique basis and decreased 6% in total. This is despite sales coming in lower than expected. We believe our inventory is in good shape, both in clearance composition and capacity or units per boutique.

The company had no debt outstanding at the end of the quarter and did not borrow during the quarter. We did not repurchase any shares of our stock this quarter, and we feel it is prudent to conservatively manage our cash, prioritizing strategic investments over share purchases. As of today, we have $40.2 million remaining under our current repurchase program.

Capital expenditures for the year-to-date period totaled $14.4 million, comprised of $7.8 million for new boutiques, $4.2 million for remodel and $1 million for existing boutiques. The remaining CapEx was spent on IT and e-commerce projects.

During the quarter, we opened 4 new boutiques and closed 6, bringing our total boutique count to 742. This consists of 352 mall locations and 390 non-mall locations, which includes 90 outlets. Our full year guidance for the boutique openings and closures is now 34 openings and 24 closures. Additionally, we refreshed 30 boutiques and are on track to refresh 80 to 85 boutiques for the year.

As noted on our last call, we closed on our asset-based revolving credit facility in May. At the end of second quarter, our borrowing availability was $28.4 million. I'd like to point out that we expect to continue to fund all of our investments in the business using operating cash. Historically, we've not dipped into our revolver and view it as an added layer of liquidity, providing us with increased flexibility to operate our business.

Turning to guidance. As Steve discussed, we are revising our back-half guidance to reflect the current traffic trend and a slower inflection in the business, as we continue to work in winning our guest back. As a result, for the third quarter, we now expect net sales of $105 million to $110 million. This is a decrease of 1% to an increase of 4% compared to last year. Comparable sales are expected to decrease between 3% and 8%. Merchandise margins are expected to improve by approximately 200 basis points for third quarter and will be somewhat offset by occupancy deleverage resulting in a flat to modest increase in total gross margins compared to last year.

Also as Steve noted, we are staying diligent in our inventory management and expect to end the quarter with an inventory per boutique down in the high single-digit range.

Third quarter SG&A dollars are expected to increase 4% to 6% compared to last year. Last year third quarter included a reversal of performance-based incentive expenses that we had accrued earlier in the year. This year, we also reversed most of our performance-based incentive expenses, but it occurred in the second quarter. Additionally, in the third quarter of the current year, we have higher corporate payroll and related expenses supporting e-commerce operations and the larger boutique base as well as an increased investment in marketing. Offsetting these increases are expected cost savings as we work to reduce any expenses that are not related to strategic investment.

The tax rate for the third quarter is expected to be 35%, as there will be an additional tax expense related to the vesting of certain stock-based awards.

Diluted shares are expected to be $35.1 million.

Finally, for the third quarter, we expect a diluted loss per share of $0.03 to a diluted earnings per share of $0.02.

For the full year, we now expect total sales of $453 million to $463 million based on comparable sales decline of 8% to 10%.

Gross margin as a percent of sales is expected to decline due to occupancy deleverage. Merchandise margins are expected to be flattish.

Additionally, SG&A is expected to increase in the low single-digit range.

Finally, diluted earnings per share is expected to be $0.15 to $0.25 compared to 2017 GAAP EPS of $0.43 and adjusted EPS of $0.52. Last year 's adjusted EPS excludes $3.3 million or $0.09 per diluted share and charges related to the remeasurement of deferred tax asset associated with the new tax law.

Capital expenditures for the year are still expected to be $30 million, including $22 million for the 80 to 85 refreshes and 34 new boutiques. We plan to open 3 additional boutiques, 1 in third quarter and 2 in fourth quarter. We also plan to close 14 additional boutiques in the back half of the year, mostly in the fourth quarter. The remainder of CapEx will be spent or has been spent on our new warehouse management system, loyalty program and other technology and corporate investments that support short-term improvement and long-term growth.

Depreciation for the full year is expected to be approximately $25 million.

This concludes the financial review, and we'd now like to open up the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Janet Kloppenburg with JJK Research.

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Janet Joseph Kloppenburg, JJK Research Associates, Inc. - President [2]

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As I recall last quarter, you guys talked a bit about having identified some of the problems in clothing, which sort of built the SKU; color count was too wide and that you were going to get back on track with the francesca's DNA. And I was wondering if you could talk in clothing, with the weakness in dresses and tops continuing, what you see now as the problem, Steve, and how long it may take to win this. I have a follow-on...

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [3]

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Yes, Janet, what I think you're referencing is, in the past, we've had some changes in leadership, as you know, in the merchandising area. And we've gone in the past time period of time where, originally, we have a very broad and shallow kind of merchandising concept. We've gone through a period of being much more narrow and deep. And we have gone back to that broad and shallow concept. So the breadth of the buys is kind of backward traditionally or historically has been. We're not buying deep buys behind anything. Generally, we're distributing fixes about something to a store, which is a small quantity. And we're selling through them on a very rapid basis. So from that perspective, we've certainly fixed the mechanics of where we were to where we are now. In terms of the weakness, we continue to see in clothing, I think, there are couple of things happening there. Clearly, there's a cycle that's away from dresses right now. And as you know, dresses is a very, very strong important category for us. It's about 40% of our clothing business. Clothing is 50% of the total means. Dresses are 20% of the total. And we've long had a really strong hand in dresses. And I think, as that business has declined, it should put pressure on the apparel business. So to offset that, what we've done is we've started building back a bottoms business to take advantage of the separates trend. So you can see denim in a much more robust way on our floor today than probably it's ever been. We're almost doubling our denim business. You see skirts coming back and making appearance on our floor. And skirts was a fantastic selling category for us. But the map of trying to replace or sell a top or a bottom for a dress, we're certainly mixing down from an AUR perspective there. At the same time, in dresses, one thing [I think we didn't do] fast enough on is there is categories beneath the surface, rompers and jumpsuits, that are doing really well. And we are shifting money pretty aggressively into -- particularly jumpsuits for fall, but then rompers again for spring to try to offset some of that as well. But it's -- I think there's a cyclical weakness in the dress business that we're reacting to, to try to offset.

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Janet Joseph Kloppenburg, JJK Research Associates, Inc. - President [4]

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And therefore, your inventory declines are pretty dramatic. But in the meantime, your investments are shifting. So when do you think you'll have that content where you wanted to be, Steve, i.e., more bottoms and less of the dresses and I don't know about tops, but when do you think that bottom will come into play?

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [5]

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I think as we get into fall selling, you'll start to see it move that direction. Our plan, from a tops to bottoms ratio, is we're going to be at 4:1, so 4 tops for every 1 bottom. Historically, if you went back last year as a reference point, we're more like 6:1. So we're landing the bottoms and flowing back into the bottoms, so you'll see that happen throughout most of the fall. In terms of getting a better position in rompers on the floor and jumpsuits, that will be an evolution as we kind of move through fall. Obviously, we have, right now, kind of a big special occasion, dress business we're delivering to take advantage of all the different events and parties that happen in the back half of the year. But we're going to steadily ramp up rompers and jumpsuits. It could be as high as 20% to 30% of the assortment in dresses during the back half of the year, and that will be more of an evolution.

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Janet Joseph Kloppenburg, JJK Research Associates, Inc. - President [6]

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Okay. And just lastly, what are your thoughts on expanding the fleet given the challenges you're experiencing on the merchandising front?

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [7]

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I think it's always an interesting question. So I'll state, first off, we haven't really given any thoughts or guidance around what we're going to do for 2019 yet. We're opening, I think, roughly 30, 35 new stores this year, closing around 25, so a net of 10. I think there's still opportunities for us out there. They need to be in the high-traffic, A+, A, maybe B+ rated centers. We have been on this journey of opening up stores in A-rated centers, while closing Cs and Bs. One of the things we're really pleased about is we -- actually, when we went through and looked at the last Green Street Advisor report, we only have one store now that's in a D-rated center and that's going to close by the end of the day -- or by the end of the year. So we are beneath the surface, optimizing the fleet and moving away from the lower traffic centers. And Janet, when we talk about our challenge, our biggest challenge right now is traffic. And as you know, we traditionally don't mark it a lot, right. I mean, we spend about 1% of our revenue on marketing, which is a low percentage spent. And then because we're a smaller company with low dollar spend, and a lot of cases are boutiques, are our marketing. And so having boutiques in high-traffic locations does help not just only our brick-and-mortar business, it also helps our dot-com business. So we still think there's a role for it, but we haven't determined what that looks like for 2019 yet.

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Operator [8]

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And we'll take our next question from Dylan Carden with William Blair.

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Dylan Douglas Carden, William Blair & Company L.L.C., Research Division - Analyst [9]

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I'm just curious. I know you've kind of walked away from talking about the fleet based on mall versus off-mall performance. But just as we're in the middle of this recovery, as it makes more sense, are you seeing any difference there as far as traffic is concerned in the 2 categories?

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [10]

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Nothing that is -- stands out candidly. I mean, the traffic was fairly broad based across types -- store types as well as geography. I think -- Dylan, I think the one thing that really has continued to stick out for us over the past year is we've been fighting through this choppy top line sales trend, as dot-com has continued to grow at very strong rates. And that's the same assortment that we have in store. So even last year, we didn't feel like assortment was great. We had a strong dot-com business and that's only gotten stronger as we feel like we've gotten better from a merchandising perspective. So one of the things we're really focused in on is we have -- we under penetrate in dot-com. We're under 10% in dot-com penetration. And if you look at a lot of our peers, they're in the 20%, 30% or even 40% range. And so what that tells us is there's definitely more of a flight to digital. And certainly, at the younger end of the customer spectrum, we probably are more susceptible to that than other different retailers who have, maybe an older clientele base. And it tells us that we've got to ramp up our dot-com business and penetration faster. So I mentioned in my talking points that we'd hired a consultant to come in and help us figure out how to do that. And we're working on what that looks like. And we'll certainly share that with you going forward once we have some concrete recommendations. But we believe part of our pathway forward to help fix the top line sales and help the traffic is to dramatically ramp up our marketing and our dot-com business.

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Dylan Douglas Carden, William Blair & Company L.L.C., Research Division - Analyst [11]

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Got you. I guess, and related to that, the marketing spend, I think you said it was up 20% in the back half. Can you just give us a sense kind of what buckets that's going to, if it's all online kind of social or what that looks like as far as particularly enhancing your online business?

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [12]

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Yes. I mean, most of what our marketing is today is digital in nature, right. We don't have a strong traditional base in marketing. We did a direct mail piece to a limited distribution at -- during the August time period. But most of our marketing is in paid search, social, influencers. So the increase will go to primarily digital channels. Now we do believe that, that also has an impact and influence on the brick-and-mortar channel. But what we have done is really focus that spend into those muscle-in time period, as I mentioned. So we know there's a couple of natural selling peaks ahead of us where we have a chance to get the guest back in to see that we're back on our game from a merchandising perspective, right. First one is when the weather turns and it gets cold. That's hard for us to predict and plan a big marketing spend around. But we do know, particularly in that late November through early mid-December time period, when the guest is coming back in, that's the next biggest and candidly the biggest natural selling time period on the calendar. And so we are really focusing our spend into that time period to make sure we're top of mind and to bring her back in. And we think that, that should help us as we get into Q4.

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Operator [13]

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And we'll take our next question from Susan Anderson with B. Riley FBR.

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Susan Kay Anderson, B. Riley FBR, Inc., Research Division - Analyst [14]

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I guess, I was curious. It seems like things must have really deteriorated from the end of second quarter call. Just wondering, I think you guys were coming up against easier comparison, June, July, August. So just kind of wondering what changed so significantly versus your original expectations.

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [15]

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So yes, as you remember, Susan, we're talking about May seemed to be an inflection point, and business was moving in the right direction. And we interpreted that, that was kind of the turning point. And that as we got deeper into Q2 and closer to that late July time period where business turns south, we've seen inflection. And we didn't, right. And so base off that, we've reforecast the back half of the year. I think when you think about where we had been, and I'd mentioned earlier that we've had this shifting edit point, where, traditionally, we've been an 18- to 35-year old with the target of that -- or the center of that target being a 26-year-old, right. And certainly, under a previous Chief Merchant, we talked about how the assortment have moved younger, maybe the edge of that edit point. I believe that probably helped us build off a back-to-school business during that time period. And if you remember, we had a really strong back-to-school business back in 2016. And even last year, with tough results, it was still -- those weeks were very overpenetrated for us versus what we traditionally sell. And moving back the edit point to the 26-year-old this year with new merchandise probably didn't resonate as much with the younger end of the spectrum. That being said, we think it was the right move. And we think we're heading in the direction, and we feel very good about the merchandise that's out there. I think the team, with new direction, is getting stronger and stronger in their voice as they move forward. And we're very excited about how it builds and grows as we head into holiday. But certainly, you're right. We'd not see the strength that we started to see in early May continue throughout the later part of the quarter.

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Susan Kay Anderson, B. Riley FBR, Inc., Research Division - Analyst [16]

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Got it. And just looking at inventory, so looks pretty clean. You ended pretty much in line with sales. I guess, how are you thinking about the back half in terms of clearance and promotions? Are you still trying to pull back? And then maybe if you could talk about your expectations per merch margin in the back half and third quarter.

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [17]

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So I'll answer the first part and let Kelly answer the second part. So our goal is we've gotten our inventory in a good place. We spent the better part of last year on defense. We had too much inventory. We're trying to push it to consumers. And so we worked really hard in the front half of this year to get back on offense from an inventory perspective. And I feel like we're there, and our plan is to stay there. So to that end, what we've done is we've really fully re-architected our financial plans. We're basing our average inventory off of boutique capacity, so that we can have more door to floor, which I mentioned in my talking points. And we're going to stick with that discipline. So that really pushes a lot of the receipts into a weekly receipt flow, which, candidly, our guest likes. They liked come in every week and see something new. So I think it's delivering against one of our core promises. So we're going to manage that inventory to capacity and to sales. And as we forecast, we plan on going into Q4 with inventory down in the high single digits, but that just gives us a lot of receipt power to deliver for holiday. In terms of promotionality, we're trying to be very thoughtful about promotionality. We are actually, right now, probably a little less promotional than we were a year ago. But that's because a year ago, we were bloated with inventory and really pushing goods at really low prices to a guest. And we're not in that place this year, so we don't need to do that. That being said, our approach on promotionality is we are going to be appropriately aggressive in promotional during the kind of natural traffic time periods. We've got to be competitive for Thanksgiving. We've got to be competitive for Labor Day. We've got to be competitive for Christmas. But the lulls in between, where it's less important, we're dialing back promotionality. And we think that -- the help -- that helps us manage the margins and it gives us the ability to be aggressive when we need to be. But at the same time, it also creates a little variability in our cadence, right. In the past, we've been kind of one note in the types of promotions we put out there, so it's hard to tell when we're really giving her a good deal. So having that variability and dialing back in the lulls also, I think, makes the peaks look more important. How that impacts our merchandise margins, Kelly?

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Kelly M. Dilts, Francesca's Holdings Corporation - Executive VP & CFO [18]

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Yes. So the merchandise margins for third quarter right now are looking to be approximately up 200 basis points. You'll get, obviously, some occupancy deleverage in that. And then total gross margin, we're looking to be flat to a modest increase for third quarter.

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Susan Kay Anderson, B. Riley FBR, Inc., Research Division - Analyst [19]

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Got it. And then, I guess, really quick on your capital allocation. Are you still expecting to spend the same amount on CapEx for the year? Or would you pull back further on opening new stores? And then, I guess, with the deterioration in profitability and the CapEx expectation, are you still going to be free cash flow positive this year?

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Kelly M. Dilts, Francesca's Holdings Corporation - Executive VP & CFO [20]

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Yes. So we're -- we are looking for some free cash flow. We are not going to decrease the CapEx this year. Most of the new boutiques have already been built. We only have a couple left that we're getting open this year. The rest of the spend is around the refreshes, which has been a good CapEx spend for us. So we want to stay on course on that for this year.

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Susan Kay Anderson, B. Riley FBR, Inc., Research Division - Analyst [21]

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Okay. And one final follow-up on the new denim product. I'm not sure if you could just talk about how that's selling.

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [22]

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Yes. I mean, it's literally just hitting the floor over the last 30 days. As we talked about in the last call, it's -- we've kind of upgraded it, so we -- it's called Harper Heritage. It's kind of the better piece of the line. We've added a lot of destruction, hem details, et cetera, so early, early days. So far, we're pleased with the performance. I think, really, the tail of the pace is going to be in the back half of the year as it gets cool around the country. As you know, it's still been fairly warm throughout most of the August. So we have high expectations as that program fully gets out in the boutiques and have the chance to really take hold of the customer.

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Operator [23]

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And we'll take our next question from Steve Marotta with CL King & Associates.

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Steven Louis Marotta, CL King & Associates, Inc., Research Division - Senior VP of Equity Research & Senior Research Analyst [24]

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Steven, as far as the rewards customers go, you have about 2.1 million signed up. Could you talk a little bit about what kind of penetration that is to the current sales mix, maybe as an estimate of your total annual customer base? How far can that go? Have you endeavored to reach out to the 2.1 million people on the success that -- I know it will be early, but driving traffic based on your ability to communicate, specifically with these reward customers?

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [25]

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So that's a very complicated question. I'll do my best to unpack it and answer it. So we don't know exactly how many people shop with us on an annualized basis. I can say that the 2.1 million represents about 40% of the total e-mail file of customers that we have. So it's not everybody in that file, which would imply that it could be much higher than that. I mean, we probably could push this number at least north of 3 million over the next year, as we look at kind of sign-up rates and what we've experienced so far, and that's probably a low number, but it's probably a safe number. In terms of engaging with them, we just did the launch and did the big sign-up over the past 30 days. And really, the first time we're going to see what the reaction of the loyal is this is going to be in our gift event that we're running in the next couple of weeks where we're literally giving away free gifts. And so that'll be a really interesting experience for us to go through because we haven't really seen it yet. So we'll certainly report back on that in the next earnings call and kind of give you a sense of how well that worked. We've got a couple of these peppered throughout the back half of the year. We've got something we're doing around Thanksgiving time period. And then we've got something we're doing in early December as well that, we think, should be fun and surprising and delighting for our customer, but also help drive traffic, which is what we're really looking to do with this into our boutiques at key time periods. But over time, we think this is going to -- this will grow, and we think that we're going to get a higher engagement from our guests in this program.

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Steven Louis Marotta, CL King & Associates, Inc., Research Division - Senior VP of Equity Research & Senior Research Analyst [26]

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Okay. That's helpful. And just one housekeeping question. As it relates to the clearance as a percent of the total inventory at the end of second quarter, it was 15%. What was that metric last year?

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [27]

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If you look at over the last -- I think, a better number, if you look at the last 12 months, we've averaged clearance anywhere from 18% to upwards of 30% at certain time periods, which is too heavy. Our plan is to manage it in this 15% range. That doesn't mean that there won't be peaks and valleys. And certainly, coming out of Christmas, right, you always have a peak there. But we were -- we had more clearance than we wanted over the past 12 months based off of the missing sales that we have starting last year back-to-school. And so getting that number to a reasonable level is very important for us. I would expect it to be managed somewhere in that 15%, 20% range with, obviously, a peak here and there maybe after Christmas.

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Operator [28]

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That concludes today's question-and-answer session. Mr. Steven Lawrence, at this time, I'd like to turn the conference back to you for any additional or closing remarks.

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Steven Paul Lawrence, Francesca's Holdings Corporation - President, CEO & Director [29]

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Thanks, operator. As I stated earlier, we haven't seen the level of inflection in sales that we'd hope to see, as the new merchandises landed. And when we stepped back and tried to understand why, we thought about the multiple changes in key leadership roles we've experienced over the past 3 to 5 years. These changes have translated in the shifting merchandising directions that have taken us from a traditional 18 to 35-year-old guest with a broad and shallow merchandising mix to the younger end of the spectrum with a narrow and deep approach, and then back again. During those transitions, we clearly lost some traction with our core guest. And while it's taking us longer than initially expected, we believe our approach is the right one in that we need to be consistent and remain focused in order to win her back. Our strategy this quarter is a simple one. We'll offer our guests well-curated assortments of product that inspire her and an updated and engaging boutique experience with high-touch customer service, while connecting with her across multiple touch points by delivering a frictionless multi-channel experience. We still have the largest national selling peak ahead of us. And we're confident that as she comes into our boutiques over the next 4 to 5 months, she will see that we're back embracing the fundamentals and make us an engaging and compelling place to shop. Ultimately, we believe that this will help us regain frequency of visits and move us back to long-term sales growth and improved profitability.

In closing, I'd like to thank the entire francesca's team for all the hard work and effort they put in over the past 12 months. Despite the challenging results, the team is resilient and is excited about where we're headed. We appreciate you joining our call today and look forward to updating you on our progress during our third quarter call.

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Operator [30]

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And that concludes today's presentation. We thank you for your participation. You may now disconnect.