FRAN
#Thanks, Matt, and good morning, everyone.
We appreciate your participation this morning in francesca's Third Quarter Fiscal Year 2017 Conference Call.
Earlier this morning, we issued a press release outlining the financial and operating results for the third quarter ended October 28, 2017.
Please note, the following discussion includes forward-looking statements and actual results may differ materially from these statements.
Additional information concerning factors that could cause actual results to differ materially from projected results are contained in the company's filings with the Securities and Exchange Commission.
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 president and CEO, Steve <UNK>.
Steve.
Thanks, Kelly.
Good morning, everyone, and welcome to our third quarter earnings call.
During our call today, Kelly and I will give you some color around the third quarter performance, along with our updated thinking on the fourth quarter and full year guidance.
We'll also give you a quick update on our progress on our longer-term initiatives.
As you saw from our announcement earlier this morning, Q3 was a challenging one for us.
Comparable store sales for the quarter came in at negative 18%, primarily driven by the merchandising missteps we discussed in our last call, coupled with the impacts of hurricanes Harvey and Irma.
Breaking them apart, we attribute 425 basis points for the decline to the impacts of the 2 hurricanes.
While both storms combined to force 112 of our boutiques to be closed anywhere from 1 to 13 days, Harvey had a bigger impact on our business as it disrupted operations at our home office in D.
C.
including both the warehouse and e-commerce fulfillment and had a longer-lasting effect on our supply chain.
One of our key merchandising disciplines is to have a constant flow of newness for our guests, and due to this disruption, we were not able to deliver against it for most of September and even into early October.
Turning to the merchandising missteps that impacted our third quarter assortments, we took swift and decisive actions to correct the problems.
These actions included: first, we made a change in our leadership in merchandising.
Hopefully all of you have had a chance to read the press release we issued November 13 announcing that Ivy Spargo has joined the team as our new chief merchant.
Ivy is a brand builder and a world-class leader with deep specialty store knowledge, including stints at The Gap, The Limited, Nike and Land's End.
Ivy officially started last week and I'm confident that she's going to have an immediate and positive impact on the business.
Second, we took aggressive markdown action in August and September to help accelerate selling on the product while we were still in the natural selling season.
While this did help accelerate the rate of sale on these goods, it did also have an impact on our margins for the quarter, which I'll cover in a minute.
Third, we worked to surgically cancel an order in the underperforming categories and items.
While this was the right thing to do in the long term, it did have a short-term impact on sales in the quarter since it also impeded our ability to flow new merchandise.
Finally, we worked hard to course correct and ensure that our Q4 assortments did not replicate the missteps from Q3.
During our last call, we noted that approximately 75% of our Q4 on order had not been committed for.
The team has worked diligently to course correct and ensure that our holiday receipts were focused on our traditional francesca's target consumer.
The aggressive markdown activity led to our Q3 gross margin coming in at 39.6% which is approximately 870 basis points below last year.
This decline in margin was the primary driver of our EPS for Q3 coming in at $0.01, which was also at the lower end of the guidance we gave for the quarter.
The combination of all these actions did help us drive inventory down 15% on a per-boutique basis, which will help [fuel] ---+ position us to deliver fresh receipts to fuel the all-important holiday season.
On a positive front, we believe that the timely actions we took in Q3 have started us moving in the right direction.
While the business was consistently challenging throughout most of August and September, we've seen sales trends get progressively better as the new receipts started to land.
While we don't think we're completely out of the woods, the selling we saw in the new merchandise receipts during the Black Friday and Cyber Week time periods was definitely encouraging.
Also, we've gotten more ---+ as we've got more of the new product on the floor, we've seen sell-throughs in AUR start to stabilize.
At this point, we expect comp sales for Q4 to run negative 9% to negative 12%.
We also expect some merchandise margin improvement versus last year in the quarter as we don't plan to anniversary the large mark-out-of-stocks that we took last year at the year end.
Based on this, we're forecasting EPS for Q4 to come in at $0.35 to $0.40 versus last year's $0.39.
While we've had to deal with several short-term disruptions to the business, we've also been working hard to remain focused on the initiatives that will be critical for our success in the long term.
2017 has been a year of investment for us and we've spent the better part of the past year putting in place building blocks for our future.
Some of these investments include: after the end of October, we completed the rollout of our new Oracle POS software to all boutiques.
We see this new POS as foundational for our long-term success as it enables several much-needed functionalities.
First, it is unlocking some much-needed omnichannel capabilities for us as we head into the holiday season.
Rapidly growing our dot-com business remains our #1 long-term priority and we now have the ability for our guests to both buy online ship-to-boutique, and buy-in-boutique ship-to-home, with both functionalities going live over the past month.
We see these 2 capabilities as key drivers of growth not only for Q4, but for the long term and we're very excited to have these new shopping options available for our guests.
The new POS system is also key in helping us develop a deeper understanding of our guests' shopping habits by enabling phone number and e-mail capture.
This enables us not only to build a more holistic view of our customer, but also is expanding our ability to reach out to these guests with our various marketing initiatives.
We've enabled this data capture as we've rolled out the POS, and through the first 3 quarters of this year, we've grown our e-mail file by over 50%.
As we turn the page to 2018, we have a second phase of functionality from our Oracle POS that we will roll out to the entire chain during the spring season including handheld scanners that will allow us to be much more efficient in taking markdowns, handling transfers, and many other labor-intensive tasks, and we will also automate our promotions going forward.
This should speed up the checkout process and allow our boutique teams to spend more time helping our guests create the perfect outfit.
A second key initiative for us is to build a deeper connection with our guests.
One of the best ways we can do this is through establishing a loyalty program.
As we mentioned in our last call, we've developed a pilot program that we've been running locally here in Houston over the past couple of months and we're pleased with the results so far.
Our plan will be to expand this program nationwide next spring and to have the program rolled out to all markets as we head into the back-to-school selling season.
Third, while we continue to see an opportunity to open up new boutiques, which we recognize the traffic patterns in brick-and-mortar stores can be challenging.
To that end, we've refined our real estate strategy going forward with a focus on 3 initiatives: first, we will only open up new boutiques in A- and B-rated centers with a heavy emphasis on the As.
We believe the landlords are committed to keeping these properties relevant and driving traffic into them by finding ways to make them more engaging and experiential.
Within our existing fleet of boutiques, we're also looking to rationalize the store count.
We will proactively drive our store count in C and D centers down from roughly 20% today to under 10% over the next 5 years.
Lastly, as a company, we have not traditionally placed a heavy emphasis on updating our existing fleet of boutiques.
You might remember that we refreshed 3 local Houston boutiques with our updated concept back in early May.
We're pleased with the continued performance in these boutiques and based on the look we've seen there, we plan to embark on an aggressive remodel program starting in 2018.
Our goal will be to update roughly 90 boutiques a year, while also using this concept in all of our new boutique openings.
Finally, we continue to look for ways to improve our processes and reduce expense.
As most of you know, one of the largest expenses we have is our staff out in the field.
To help us better manage this going forward, we worked with an outside consulting firm to help build out a new store-level staffing tool.
The team has worked hard to get this tool up and running and we're utilizing it to help optimize schedules for the entire chain as we head into holiday.
We feel that this tool will be a huge help for us in 2018 and beyond.
As I stated earlier, while we still have a lot of progress to be made, we feel that the work which we've been doing over the past several months is helping us see improvements in the business and should position us to start reclaiming our competitive moat and deliver on our fourth quarter guidance.
On a longer-term basis, we have spent most of 2017 laying out a lot of foundational work for the future.
We believe that we should start seeing a pay-off for this work in the fourth quarter with the majority of the benefit being felt in 2018 and beyond.
We also believe that our differentiated positioning in the market continues to set us apart and will allow us to not only survive, but thrive in the fast-paced evolving retail marketplace.
Now I'd like to turn it over to Kelly who will do a deeper dive on the financials.
And after that, we'll open it up for questions.
Kelly.
Thanks, Steve.
Today, I'll discuss our third quarter 2017 results as well as provide some color around our 2017 fourth quarter guidance and our revised full year guidance.
Net sales for the third quarter decreased 11% to $105.8 million compared to $119.5 million last year, primarily due to an 18% decrease in comparable sales.
We primarily attribute the decrease to a lower conversion rate as well as a decline in boutique traffic as our merchandise assortment did not resonate with our guests.
As we discussed in our last call and as discussed by Steve during his prepared remarks, we deviated from our core merchandising philosophy and [core guests], which resulted in poor sales.
In order to work through this inventory, we took heavy markdowns, which led to a decrease in the average unit rentals ---+ or average unit retail, but was partially offset by an increase in units per transaction.
Hurricanes Harvey and Irma also adversely impacted comparable sales by approximately 425 basis points.
As discussed, the impact of these hurricanes went beyond boutique closures.
Our corporate offices, located in Houston, Texas were shut down for a few days and deliveries were interrupted for several weeks.
As a result, we were not able to receive merchandise into our distribution center, fulfill e-commerce orders, or ship fresh merchandise to our boutiques.
Because our operating model relies heavily on fresh merchandise, this disruption had a significant impact on sales for all boutiques and e-commerce.
The comp decrease was partially offset by 45 net new boutiques opened since the third quarter of last year.
Additionally, we recognized $1.5 million of gift card breakage income during the quarter due to a change in the redemption period estimate.
During the quarter, we opened 23 new boutiques and closed 1, bringing our total boutique count to 714.
This consists of 348 mall locations and 366 non-mall locations, including 68 outlets.
Note that several boutique openings during the quarter were delayed and are now expected to open in the fourth quarter of this year or first quarter of next year.
Total gross margin for the third quarter decreased 860 basis points to 39.6% from 48.2% in the prior year due to a decrease in merchandise margins related to deeper markdowns and significant occupancy cost deleverage.
This decrease was more than expected as we took additional markdowns and inventory reserve on the slow-moving product.
Third quarter SG&A expenses decreased 1% to $41.4 million compared to $41.9 million in the prior year.
This decrease was primarily due to a decrease in short-and long-term performance-based incentive expenses as the achievement of the required performance metric is not probable given our current financial results.
This was offset by higher corporate and boutique payroll to support our new boutiques and infrastructure investment.
Higher professional fees and software fees related to our continuing investments in technology, including our new POS, CRM and HR systems, and higher marketing expense.
Our effective tax rate for the third quarter was 45% compared to 38.3% last year.
The increase in our effective tax rate was principally due to $69,000 in net income tax effect related to stock-based awards.
This had a magnified effect on our tax rate because of the low pretax income.
In previous years, this expense would have been recognized in additional paid-in capital.
Diluted EPS for the third quarter was $0.01 compared to $0.26 last year.
This is within our guidance of flat to $0.05.
Now let's turn to the balance sheet.
We ended the quarter with $19 million in cash compared to $24.7 million at the end of the third quarter last year.
The third quarter is typically our lowest cash quarter as we build inventory for the fourth quarter.
The company had no debt outstanding at the end of the quarter and we did not borrow during the quarter.
Inventory at the end of the quarter decreased 9% to $38.8 million from $42.8 million in the prior year.
On a per-boutique basis, our ending inventory was approximately $54,000, down 15% compared to last year's third quarter level of $64,000 and was consistent with our sales decrease.
This is favorable to our guidance of a high single-digit decrease in per-boutique inventory.
During the third quarter, we repurchased 491,000 shares of our common stock at a total cost of $3.5 million.
At the end of the quarter, we had $45.2 million remaining available for future repurchases under the $100 million program announced last year.
Our primary use of cash is investment in our long-term strategies, which we believe will have a strong return.
Steve and I, along with our board of directors, will continue to evaluate the best use of excess cash and our capital structure.
Now let's move on to our guidance.
We revised our full year guidance based on third quarter actual results, as well as a revision to our fourth quarter expectation.
When we gave guidance on our last call, we were in the midst of the hurricane supply chain disruption and were trying to disentangle that impact from the merchandise issue.
Now that we have more visibility on the delineation, we are better able to understand the trends going into the fourth quarter.
As previously guided, we expect fourth quarter to sequentially improve from the third quarter.
However, it is lower than what we had previously guided.
For the fourth quarter, we expect net sales of $145 million to $150 million, a decrease of 1% to an increase of 2% versus last year.
This assumes a 9% to 12% decrease in comparable sales and 9 new boutiques opening in the quarter.
Please note that our sales guidance includes November actual results, but we have much of the quarter's volume left to come during this holiday season.
Total gross margin is expected to increase modestly versus last year, primarily as a result of lower mark-out-of-stock charges, somewhat offset by occupancy deleverage.
As a reminder, last year we took a large mark-out-of-stock expense in order to start fiscal year 2017 with the right inventory level to implement our end season clearances strategy.
This strategy has been successful and while we had merchandise issues in the third quarter, we have still been able to lower our mark-out-of-stock expense compared to last year.
SG&A for the fourth quarter is expected to increase in the high single-digit range, primarily due to infrastructure investments, new boutiques and marketing.
Diluted earnings per share for the fourth quarter are expected to be in the range of $0.35 to $0.40 based on 35.7 million diluted shares outstanding and a 38% tax rate.
This compares to the prior year's diluted EPS of $0.39.
Based on our third quarter results and our fourth quarter outlook, for fiscal 2017, we now expect total sales of $478 million to $483 million, a decrease of 1% to 2% versus last year.
This assumes a 9% to 10% decrease in comparable sales as well as 52 net new boutiques for the year.
Also please remember that fiscal 2017 is a 53-week year.
So our guidance includes approximately $5 million to $6 million in sales for the 53rd week.
I'd also like to remind you that this additional week is expected to be neutral to EPS.
We expect total gross margin for the year to decrease compared to last year, primarily as a result of occupancy cost deleverage.
We expect full year SG&A to increase in the high single-digit range compared to fiscal year 2016.
Diluted earnings per share for fiscal year 2017 is now expected to be in the range of $0.67 to $0.72 versus the prior year EPS of $1.09 and prior guidance of $0.71 to $0.81.
Assumed in this guidance range is average diluted shares of 36.3 million and an effective tax rate of 38.7%.
Capital expenditures for the year are expected to be in the range of $30 million to $33 million, primarily for new boutique openings, existing boutique remodels and relocations and IT and corporate investments.
This concludes the financial review, and we'd now like to open up the call for questions.
Operator.
We'll try to tag team that.
I'll take the second part of the question.
When we look at what we're starting to see in terms of improvement, particularly over the last couple of weeks, we do attribute a lot of that to the merchandising change or pivot.
When you think about what we talked about in the last call, we'd mentioned that we had 75% of the receipts still to be placed.
That being said, when you think about it, as you get deeper into the quarter, we were more liquid, right.
So the early November time period was somewhat placed, but as we got deeper in, we had more open to spend.
And we've really seen a positive reaction to a lot of the new products from a sell-through perspective, rate of sale, et cetera.
So we feel really good about that.
I think our challenge that we're still seeing is, there's still some of the old ---+ that clouds the customer's viewpoint or visibility to the new.
And so we believe as we get deeper and deeper into the quarter and the new starts to become a bigger more prevalent piece of the floor, we'll see the sales trends continue to get better.
So that would be the ---+ what we're seeing in terms of improvement from a sales perspective.
Right.
And regarding the 2-year stack, that ---+ you are absolutely correct on the lower end of the guidance, but on the upper end of the guidance, it does show a sequential improvement in the 2-year stack, so that's kind of the range.
Yes.
I would say we're not ---+ in the past, we've talked about outlets as a separate strategy and we really don't think of it as a separate prong of our strategy going forward.
I mean, we want to be in the best possible locations, the A and B centers, as I mentioned, with a heavy weight towards A if it's a main outlet, it's going to be a candidate for a new boutique for us.
So it's ---+ we're somewhat agnostic of, of outlet ---+ or even mall more often, well, candidly, it's just A- and B-rated centers.
In terms of the total store count, we've previously talked about the number being somewhere north of 900.
We haven't zeroed in on exactly what we think the number is end state.
I believe it could be somewhere between 900 to 1,000 stores at full maturity, but we're also doing a lot of work, not just in looking for locations where we could open stores, but, as I mentioned, rationalizing our store count and making sure we're very aggressive about shutting down these Cs and Ds.
So that's still a work in progress, but I would say somewhere between 900 to 1,000 stores would be probably the end state for us from a (technical difficulty) [strategic] count.
So I'd say a couple of things.
When we look at the opportunity to kind of pivot and change our merchandising focus, really what it was and I think Kelly talked about, and I mention it in my script as well, it's refocusing on who our core guest was.
And you might remember in the last call, we talked about some of the things we felt like we missed on.
We probably had product that was overengineered, had too many trends in it.
So one of the things we've gone back to the team and worked on, is making sure that, that everything has a great hand, a great fabric, feels fantastic, has special details on it, but isn't overly engineered or overly tricked up.
So usually, it's a great warm-handed product for fall.
One of the key fabrics for us is a brushed [cochi], feels almost like a lightweight cashmere, so it feels fantastic.
And it's got one detail on it.
Maybe it's a tie hem or a sleeve detail, not 3 or 4, which is one of the things when we kind of diagnosed our problems in back-to-school we felt like we had done.
Focus on value, making sure that these things relative to our competitive set offer a great value so setting a fair price upfront on it has been another thing we've worked on.
So I think those ideas do translate into spring.
I mean, obviously, as we move from long sleeve to short sleeve products in spring, you start shifting fabrications, moving to lighter-weight fabrications, but it's still going to be about great hand, great detail, value-packed, on-trend, not too far ahead of the trend.
So I definitely do think those things have legs into spring.
We ---+ as you've called out, we do underpenetrate on bottoms and see there being an opportunity to improve our bottoms-to-tops ratio.
We've had a big push on denim this fall.
We feel like that's paid off for us.
Obviously denim becomes a little less important as we get into spring or even later into the summer months, but we definitely continue to see a bottoms opportunity.
But recognize that it's still not going to be the predominance of our assortments, still going to be primarily a tops-driven assortment.
Yes, I mean, I would tell you, that's one of the things that's really exciting about the new POS that we're rolling out is, traditionally, we've only had really some pretty good data on our dot-com or online customer.
We haven't had great data on our brick-and-mortar customer.
Our sense is, there's a fair amount of overlap between the 2, but the short answer is we don't have a lot of statistics behind that, we're building that database and can probably give you better data ---+ or better visibility into that into the future.
Right now, our sense is that there's a fair amount of overlap, but I don't have statistics that can tell you that.
So I'll try to answer your questions in order.
In terms of the Black Friday - Cyber Week performance, yes, they were better than the performance we saw, obviously, in the earlier part of November and certainly better than what we saw in Q3.
So we have seen trends improve based off of that and we do attribute a lot of that to the new product landing.
In terms of category performance, if you look at Q3, it was pretty lackluster across most categories.
We do believe, obviously certain categories, such as apparel, jewelry are traffic drivers for us.
Other categories feed off the traffic, right.
So we know getting apparel right is a key part of our success going forward.
Within apparel, we've seen certain categories, we mentioned bottoms continues to be ---+ do well, but once again, it's a small percentage of the total.
Tops more recently has been improving, so we're pretty excited about that.
Our dress business has been a bit challenging candidly in Q3 and it's continued into Q4.
So we're doing a lot of work on trying to get our dress business back up to speed.
And that is something that's kind of we're known for, so we've got to get that fixed.
Jewelry, earrings have been doing very, very well.
So we're pretty excited about our earring trend.
Necklaces haven't been as great.
So we do see a trend or a shift there between the 2.
Gifts, we've got a lot riding on gifts for holiday, I think that's a differentiator for us.
And we've done a lot to kind of change up the assortment.
And the new categories that we've gone into in a bigger way, such as kids and tech and beauty have all done really well for us.
So we feel pretty good about that going forward.
Shoes continues to be a standout for us as well.
In terms of slowing down our brick-and-mortar stores, we really don't believe or feel like there's a cannibalization of our brick-and-mortar business by our dot-com business.
We believe, as I kind of responded, I think, to Pam's question, that it is an omnichannel shopping customer, and they want a frictionless environment.
We see them complementing each other.
We know that as we open up new boutiques and new markets where we're underpenetrated, it helps us build our brand awareness.
With the functionality we're putting in place in terms of buy online, ship-to-boutique or buy-in-boutique, ship-to-home, we see those as things that are helping complement each other.
So we're trying to be very thoughtful about our real estate.
I guess, the thing I'd want you to take away from it is we're not just blindly opening up stores.
We put a lot of rigor into the process around determining locations.
We've raised the hurdle rate internally in terms of what we want a new store to produce to make sure we're being very challenging and requiring of ourselves.
And we're being more aggressive on store closures.
So I think we ---+ it will [go down to see] slightly from our initial estimate for next year.
But we don't see one cannibalizing the another, to be honest with you.
Well, I'd say a couple of things.
I mean, yes, we do ---+ on one hand, we do not traditionally at this point in time give spring guidance, right.
I mean, we still have almost 70% of the fourth quarter ahead of us.
And so it's hard to extrapolate a number off another number, but our general sense is that we see the business starting to stabilize in the spring season, so we see it getting progressively better quarter-over-quarter.
We have our new chief merchant Ivy who's come in.
She's hit the ground running, but in terms of her full impact on the assortment I would expect it to be really back-to-school when you kind of see her vision fully formed on the floor.
So I think you're going to see that being a big inflection point for us.
In terms of fixing our dress business, we've got a lot of energy and effort behind that.
And as a matter of fact, we recently are bringing back our dress buyer who had left the company in early spring, she's coming back.
And she certainly has a great eye and viewpoint on who our guest is, and we think that she's going to be instrumental in helping us turn around the dress trend there.
Great.
Thanks.
I'd like to, first off, thank the entire francesca's team for all their hard work over the past quarter as we prepared for this all-important holiday season.
As I just mentioned, we still have roughly 70% of the quarter's business ahead of us and I know that the hard work and effort that the team has put in is just starting to pay off.
And I also want to thank everybody for joining the call today and we look forward to talking to you again during our fourth quarter earnings call.
