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Edited Transcript of FRAN earnings conference call or presentation 3-May-19 12:30pm GMT

Q4 2018 Francesca's Holdings Corp Earnings Call

HOUSTON May 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Francesca's Holdings Corp earnings conference call or presentation Friday, May 3, 2019 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

* Michael D. Prendergast

Francesca's Holdings Corporation - Interim CEO

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Presentation

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Operator [1]

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Greetings, and welcome to Francesca's Holdings Corporation Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would not like to turn the conference over to your host, Kelly Dilts, CFO.

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

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Thanks, and good morning, everyone. We appreciate your participation this morning in francesca's Fourth Quarter Fiscal Year 2018 Conference Call. Earlier this morning, we issued a press release outlining our financial and operating results for the fourth quarter ended February 2, 2019.

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 Forms 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 statements whether as a result of new information, future events or otherwise.

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

We will begin today's call with comments from our Interim CEO, Michael Prendergast. Michael comes to us Alvarez & Marsal where he is Senior Director in retail performance improvement practice. He has an extensive retail background with over 20 years of senior leadership experience. Michael has been instrumental in developing our turnaround plan and we're happy to have him on the team.

I'll now turn the call over to Michael.

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Michael D. Prendergast, Francesca's Holdings Corporation - Interim CEO [3]

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Thank you, Kelly. Good morning, and thank you for joining us on our call today. I'm pleased to be here today to discuss the rapid progress we are making in our turnaround strategy for francesca's. With over 20 years of operational experience in the retail industry and after evaluating all aspects of the business, I can confidently say that francesca's is well positioned within the new retail landscape to succeed. We have started implementation of a company-wide turnaround strategy that we believe will return the company to profitable growth.

Before sharing details of the plan with you, I would like to first discuss some of the strategies and tactics that have driven our recent results. Starting in January 2019, we executed a system-wide analysis to determine overall operating strengths, weaknesses and opportunities in the business, its overall strategy and its operating model. Upon evaluating the business, we quickly recognized francesca's unique competitive position.

The company was built on a concept of a read and react procurement process of products or its customers. It offered a broad and shallow assortment of on-trend fashion apparel, jewelry, accessories and gifts at attractive prices in a fun boutique-like shopping environment. We believe this business model is well positioned in the current environment as consumers demand a diverse trend-right fashion assortment, constant newness, an exciting shopping experience and compelling value.

Our buyers work closely with our vendor partners to procure on-trend quality merchandise while our short lead times allow for quick reaction to changing fashion trends and consumer demand. This allows for a continuous flow of new merchandise into the boutiques, encouraging frequent visits as customers look to discover something new. The intimate boutique atmosphere is also a key differentiator as we offer our product assortment in a small 1,450 on average square foot format with high-touch personalized service.

These attributes drove the early success of francesca's. However, suboptimal execution and a lack of focus on these key core success principles have caused significant comparable sales declines in recent years. Comparable sales declined 14% in fiscal 2018 following an 11% decline in 2017. During the fourth quarter period, comparable sales declined 14% and adjusted operating loss was $500,000 compared to operating income of $10.4 million in the same period last year.

Based on our observations, we attribute the weak performance over the last 2 years primarily to a shift away from core activities that historically drove successful results. The merchandising, buying and planning teams began to operate a more complicated process that slowed their reaction time to read and react to product trends in the market. Multiple reporting and personnel layers were built into the organization, for example, the merchandising and buying departments, which slowed the overall process. In addition, based on the strategy to move away from operating a demand-based product assortment to our customer, product lead times were lengthened which mitigated the ability to react quickly to changing fashion trends. Our product team selections of product were misaligned with consumer demand, both from a fashion viewpoint and classification and sub-classification structure architecture.

In short, the company was not effectively operating as a demand-based fast fashion model. The increased layers in not only the merchandising and buying areas, combined with higher payroll at the boutique level, also led to a bloated corporate expense structure. Finally, while the company was aggressively growing the boutique base, there was not disciplined management of the existing leases.

Having identified the missteps in execution over the last 3 months, we have developed and started implementation and execution of a strategic plan that we believe will return the company to positive sales, cash flow and operating income performance. With just 3 months underway, we are already beginning to see the impact of our initiatives.

First, we have made fundamental changes in the business to deliver -- to ensure our merchandise assortment is driven by and aligned to customer demand. These changes are enhancing the merchant team's chances of success and have returned the operations to some of the previous activities that made it successful. We accomplished this by instituting merchandising policies that enable us to more swiftly react to consumer demands by transitioning to more nimble, less complex processes, instituting advanced data and analytics around decision making and shortening lead times with our vendors. In addition, refocusing teams on market trends and consumer demands. Our merchandise assortment will be guided by deliberate category and subcategory hierarchy focused on 3 types of merchandise: fashion, seasonal and core, to ensure that our merchandise offerings are balanced and relevant to our customers. We will maintain a well-curated broad and shallow assortment within this hierarchy.

Second, we are reinstituting demand-based fast fashion principles in our merchandise planning and buying processes that will enable a steady flow of on-trend merchandise into our boutiques and e-commerce site which we believe will drive improved sales. The following strategies are designed to help us better implement those principles.

Number one, we are updating and adding robust analytics to our planning and buying processes in order to more quickly react to fashion trends and respond to high-demand merchandise with our customers.

Number two, we are increasing the flexibility of our planning such that a greater portion of our merchandise will be open to buy in season, enabling our style selection and inventory investments to better respond to customer demand. We will keep 50% of our open-to-buy available to chase current fashion trends as well as ensure we have the right amount of core inventory on hand. We are working closely with our key fast fashion vendors to further reduce lead times to approximately 4 weeks to again ensure we can keep pace with changing trends and customer demand.

And number three, we are activating a wide-scale testing strategy to help evaluate promotional strategies in-store with the goal to expand impactful wins to all stores.

The success of implementing these fast fashion merchandising principles is clearly illustrated in our recent NEW + NOW initiative launched in April. This product selection and offering reflects our return to fast fashion merchandise planning and buying principles. Chasing products based on store data, we recently purchased 30,000 units within a 2-week lead time and delivered it to stores which resulted in a 50% sell-through in the first week of launch. Our ability to drive these results in such a short period indicated the impact of the changes we have been implementing.

By the second half of this year, both our merchandising, buying and planning will be completely converted to a demand-based, fast fashion model which will position us to drive improved conversion and traffic. To lead this effort, we have appointed an Interim General Merchandise Manager to oversee this transition and ensure the execution of the go-forward strategy.

Third, we have taken aggressive steps to reduce costs and right-size the expense structure. The cost structure of the organization outpaced the sales levels and was saddled with added layers within various business functions. We have instituted corporate overhead reductions that are expected to result in $8 million in annualized savings before cost to achieve while lower third party-related costs are expected to yield additional savings. We plan to continue to look for further efficiencies in selling, general and administrative costs in the remainder of fiscal 2019. For example, in February 2019, we instituted robust and detailed expense controls and review processes. We believe these actions will have a direct impact on our profitability in both the short and long term.

Fourth, we are taking steps to improve the productivity of our boutique teams. By monitoring our boutique labor and sales metrics, we can better utilize our sales associates' time without sacrificing the customer experience. For example, certain tasks that were previously performed by our associates after store hours will now be completed when our boutiques are open but during the windows that our data shows that the boutique traffic is lighter. Additionally, our use of an enhanced scheduling tool that will be continuously reviewed and refined should better align boutique payroll expense to sales levels. We expect the rationalization of boutique payroll to generate an additional $7.5 million in annualized savings.

Fifth, turning to real estate. Simultaneous to the boutique productivity deterioration, the store continued to expand without adequate management of the existing fleet. As such, we are focused on optimizing the lease expense structure for our existing boutiques with an emphasis towards calibrating occupancy cost with sales levels and negotiating with landlords for early lease terminations or rent concessions for underperforming boutiques and early lease extensions for our best-performing boutiques. We are also working diligently to evaluate boutiques performing at the bottom 20% of the chain. We will continuously monitor these boutiques to identify opportunistic closures that would minimize any potential associated write-offs. For fiscal 2019, we plan to open 4 boutiques and expect to close at least 20 boutiques. We will be pausing remodels this year as well.

In summary, we have taken numerous steps toward developing a strong foundation in implementing operational disciplines that will enable improved performance across all financial metrics. We expect the merchandising and promotional strategies we are instituting to result in comparable sales stabilization and merchandise margin expansion in the second half of fiscal 2019. We also expect lower SG&A in fiscal 2019 as a result of the cost reductions we have put in place as well as the improved expense disciplines. We have made meaningful progress over the last 3 months and look forward to sharing updates on our progress in future calls.

Before turning it over to Kelly, I will touch on the strategic review process we announced in January. We have retained advisers to assist in the review of possible strategic alternatives. We have not set a timetable for the completion of the review process and we do not intend to comment on the process unless a specific transaction or other alternative is approved by our Board of Directors, the process is concluded or it is otherwise determined that further disclosure is appropriate.

With that, I will turn the call over to Kelly to review our fourth quarter and full year financial performance.

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

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Thanks, Michael. Our discussion today will focus on a review of our fourth quarter 2018 adjusted financial results followed by an update on our progress so far in fiscal 2019. I encourage you all to refer to our press release for a reconciliation of GAAP results to the adjusted results we will primarily discuss today.

Net sales for the fourth quarter, while disappointing, fell within our guidance for the quarter. Net sales decreased 14% to $119.3 million compared to $138.5 million in the same quarter last year primarily due to a 14% decline in comparable sales as well as $5 million in sales in the prior year's 53rd week. The decrease in comparable sales was due to the low-teen decrease in boutique traffic and a mid-single-digit decline in boutique conversion. These declines were offset by a mid-single-digit increase in total average ticket due to higher average unit retail.

E-commerce sales were not as strong as expected, posting a low-teen gain. The increase was driven by both traffic and conversion. However, it was offset by average ticket. The decline in average ticket was due to lower units sold per transaction. We believe this decline was a result of our higher ticket prices in the fourth quarter as well as a higher penetration of clearance sales in the prior year. During the quarter, e-commerce accounted for about 10% of our total sales.

Gross margin for the period was 39.3% versus 43.9% in the prior year. The 460 basis point decline in gross margin rate was due to 320 basis points of deleverage on occupancy costs due to the lower sales as well as the impact of higher occupancy cost per boutique. These increased costs were associated with higher rent as we move into better locations and depreciation associated with the increased construction cost of the new boutiques and remodels. Additionally, merchandise margins declined 150 basis points as we took additional markdowns to sell through our merchandise. We carried a higher average unit cost as we added back quality to our clothing assortment but were unable to fully recover that in the average unit retail.

Excluding a net expense of $0.7 million associated with onetime professional fees and stock comp reversal for the former CEO, SG&A decreased 6% to $47.4 million from $50.3 million in the prior year. This decrease was mostly due to lower payroll resulting from boutique labor efficiencies, having 1 less week of payroll in 2019 (sic) [2018], lower severance expense than the prior year and other lower G&A expenses. These results are favorable to our guidance, reflecting some of the early work done around expense management that Michael discussed earlier.

During the quarter, we booked an additional noncash asset impairment charge of $5.6 million related to the write-off of boutique assets for 24 underperforming boutiques as well as a write-off of furniture and fixtures purchased before our decision not to open new or remodel boutiques in fiscal 2019. For the full year, we recorded noncash impairment charges of $20.1 million. These charges have been excluded in our adjusted results.

Our GAAP effective tax rate for the fourth quarter was 212.1% compared to 63.9% in the last year. Let me explain. In the fourth quarter, we incurred a noncash charge of $17.1 million associated with a valuation allowance provided on the net deferred tax assets. A valuation allowance is recorded when it is concluded that it's more likely than not that deferred tax assets will not be realized. Income tax expense in the fourth quarter of the prior year included a noncash charge of $3.3 million resulting from the remeasurement of our net deferred tax assets using the lower federal corporate income tax rate under the Tax Cuts and Jobs Act. Excluding both of these noncash charges, our adjusted effective tax rate for the fourth quarter of 2018 was 38.8% versus 31.5% last year.

Our adjusted net loss for the fourth quarter was $372,000 or $0.01 loss per share, which is favorable to our guidance and it compares to adjusted net income of $10.4 million or $0.20 diluted earnings per share in the prior year. For the full year, our adjusted net loss was $9 million or $0.26 loss per share compared to an adjusted net income of $18.9 million or $0.52 of adjusted diluted earnings per share for 2017.

Turning to the balance sheet. Inventory per boutique was flat compared to last year if you exclude the $3.7 million of inventory reserves in the prior year for product that was eventually marked out of stock. Capital expenditures for the year totaled $26.2 million comprised of $8.4 million for new boutiques, $10.5 million for remodels and $3.9 million for existing boutiques. The remaining $3.4 million in CapEx was spent on e-commerce, IT and corporate projects, including a warehouse management system for our e-commerce operations that went live in October. We believe this system has already provided us with efficiencies in our e-commerce fulfillment center and should also allow a more accurate view of the inventory on our website.

During the quarter, we opened 1 boutique and closed 12, bringing our total boutique count to 727. During the year, we opened 32, closed 26 and refreshed 81 boutiques. While the remodels have continued to perform at a premium to the chain, we are pausing on the program for fiscal year 2019 until we stabilize the business.

Additionally, as Michael stated, we are focusing on optimizing our occupancy cost and real estate footprint. We plan to close at least 20 boutiques in 2019 with a focus on negative contribution margin boutiques that are at the kick-out period or lease end. Our analysis indicates that closing these boutiques earlier would be costlier than the cumulative negative contribution margin over the term of the lease. Additionally, we believe the closures we have identified for fiscal year 2019 will not only reduce our fixed boutique cost but, coupled with the recapture of some of the sales in the remaining boutiques, can better leverage the go-forward four-wall cost.

We ended the fourth quarter of 2018 with $20.1 million in cash compared to $31.3 million at the end of fourth quarter last year. The company had $10 million in debt outstanding at the end of the quarter under our asset-based revolving credit facility.

During the first quarter of 2019, we borrowed an additional $5 million while we were waiting to receive our $8.5 million tax refund. We received the refund on April 22 and repaid the $5 million, bringing our outstanding debt back down to $10 million. As of yesterday, we estimate we had $13 million in cash and $14.6 million in availability under our ABL.

Now for an update on our progress so far in fiscal 2019. As Michael noted, the turnaround plan has begun. The first of the initiatives we implemented began in mid-February with the rightsizing of our expense structure and optimizing boutique labor. We have identified and believe we will realize almost $15 million in expense savings before costs associated with those savings during 2019, and we will continue to look for more.

The next 2 initiatives of delivering a more on-trend merchandise assortment and a renewed emphasis on demand-based fast fashion planning and buying processes will take a little longer to fully realize. We are very pleased with the early successes we've seen, such as in our NEW + NOW initiative, which represented a small capsule of products. But as we more broadly implement these strategies in the second quarter and even more fully in the second half, we expect to see a more pronounced improvement in our comparable sales results. For the first quarter, the changes are promising but too small to impact our comp. Therefore, our expectation is for comparable sales to be similar to or slightly better than our fourth quarter results.

Our last initiative of real estate and occupancy cost optimization will be implemented over the course of 2019 but more fully realized in 2020.

This concludes the financial review. But before I turn it back over to Michael, I'd like to close by thanking the accounting and finance team who have worked tirelessly to close year-end, implement lease accounting and support our strategic alternative review and turnaround plans. Thank all of you for your hard work.

Now I'll turn the call back over to Michael for his closing remarks.

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Michael D. Prendergast, Francesca's Holdings Corporation - Interim CEO [5]

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Thank you, Kelly. In closing, I'd like to say thank you to the senior leadership team and overall organization for all of their hard work, efforts, dedication and support in helping to build and implement and execute the strategic turnaround plan. In a very short period of time, we have made significant changes and improvements to the business which we believe over time will help to improve our financial performance. Thank you.

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Operator [6]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.