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Francesca's Holdings (NASDAQ:FRAN)

Q1 2013 Earnings Call

June 05, 2013 4:30 pm ET

Executives

Randi Sonenshein - Vice President of Finance & Investor Relations

Neill P. Davis - Chief Executive Officer and Director

Mark J. Vendetti - Chief Financial Officer and Senior Vice President

Analysts

Jennifer M. Davis - Lazard Capital Markets LLC, Research Division

Randal J. Konik - Jefferies & Company, Inc., Research Division

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Laura A. Champine - Canaccord Genuity, Research Division

John D. Kernan - Cowen and Company, LLC, Research Division

Lindsay Drucker Mann - Goldman Sachs Group Inc., Research Division

Howard Tubin - RBC Capital Markets, LLC, Research Division

Janet Kloppenburg

Lizabeth Dunn - Macquarie Research

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

Mark K. Montagna - Avondale Partners, LLC, Research Division

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Francesca's Holdings Corporation first quarter 2013 Earnings Conference Call. As a reminder, today's conference is being recorded. [Operator Instructions]

I would now like to turn the conference over to Ms. Randi Sonenshein, Vice President, Finance and Investor Relations. Please go ahead, ma'am.

Randi Sonenshein

Good afternoon and welcome to Francesca's' first quarter fiscal 2013 conference call. Earlier this afternoon, the company issued a press release outlining the financial and operating results for the first quarter ending May 4, 2013. The following discussions may include forward-looking statements. Please note that actual results may differ materially from those statements. Additional information concerning factors that could cause actual results to differ materially from projected results is contained in the company's filings with the Securities and Exchange Commission.

We will begin today's call with Neill Davis, our Chief Executive Officer, who will comment on our first quarter performance and strategic initiatives. Mark Vendetti, our Chief Financial Officer, will then provide financial highlights of the first quarter as well as details of our financial outlook for the second quarter and fiscal year 2013. Also included on the call is Theresa Backes, our President and Chief Operating Officer. Following prepared remarks, we will be pleased to address your questions. As usual, the text of today's conference call, along with detailed management commentary, will be posted to our corporate website. I'll now turn the call over to Neill.

Neill P. Davis

Thanks, Randi, and good afternoon, everyone. Francesca's track record of driving strong, double-digit growth rates in both top line sales and bottom line profitability continued in the first quarter with a 29% increase in total sales and a 25% increase in net income. I am pleased that we met our earnings expectations in a challenging retail environment, marked by unfavorable weather comparisons to the prior year quarter, which Mark will outline the effects on our business in greater detail in his prepared remarks.

The underlying drivers of Francesca's continued performance are embedded in our strategic priorities. These priorities include our new boutique opening initiatives, introduction of the Francesca's brand to a broader market via a direct consumer channel and continuous operational improvements. All of which, are framed in the context of preserving the competitively differentiated aspects of our business, those being a boutique-like experience, a highly-curated merchandise assortment and a great value for customers. We have made solid progress on all of these fronts during the first quarter.

So let's first touch on boutique growth. The most significant driver to our sales growth has and continue to be new boutique openings. We opened 56 boutiques during the first quarter, which is up from opening 44 in the first quarter of last year. And sales productivity of those new openings is running stronger than our internal pro forma targets. Several new location opportunities have materialized over the course of the first quarter. And as a result, we're expanding our new boutique opening target for the full year to 85. This is up from an initial plan of 80. This would take our planned boutique base to 445, which represents 49% penetration of our 900 boutique goal within the United States. We have a significant runway ahead of us and the availability of productive venues for our business model continues to be robust, as reflected in the fact that we have entered into 60 letters of intent for new boutique openings in fiscal 2014.

Next, let's touch on our direct-to-consumer initiatives. In November 2012, we embarked on a multi-phase strategy to improve our direct business. The first phase, completed at March 2013, was a relaunch of our online presence with enhancements that improve the overall shopability of francescas.com. Our direct to consumer offering is now cleaner, more intuitive, easier to shop and offers an expanded style assortment as well as online exclusives. The response to the new look and updated shopping experience has been overwhelmingly positive thus far, specifically, traffic, conversion rates, average transaction values and unit per transaction have all experienced double-digit rates of improvement over the prior year quarter. In addition, our email address database continues to build at a significant pace, up 23% over fourth quarter of 2012.

As I've said on previous calls, our objective is to create an experience that is fun, gives her a reason to keep coming back, is an experience worth sharing with friends, drives site traffic and ultimately, sales. I would also say -- I also have said that it would be a multiyear process to get there. Let me now be a little more specific.

Over the next 12 to 18 months, our plans include building out the necessary infrastructure and customer service to support and track emails and calls efficiently; to add systems to support marketing efforts designed to drive site traffic and support future growth; to add systems for data accumulation and analytics to better understand improve conversion rates and support our personalized shopping strategies; and lastly, to implement a scalable, digital enterprise platform to support growth and equally important, maintain a stable environment. Rounding out our strategic priorities is our commitment and focus on continuous operational improvement to complement our new growth objectives. These initiatives are broad-based throughout the organization. Our merchandising teams are focused on satisfying our customer's passion for newness, novelty and one-of-a-kind items and offerings. Our teams in the boutiques are adding to training protocols to enhance the customer experience and drive improved conversion rates.

We are developing new boutique design protocols and support the unique and differentiated boutique shopping environment, aligned with regional and local preferences. We will test and implement those as we move through our planned boutique remodels later in the year. We also achieved a milestone of successfully completing the chain-wide rollout of our new point-of-sale system. With this solution now fully in place, it will be much easier to share information between boutiques and make for a more personalized customer experience each time she makes a purchase. Overall, the fundamentals of our business remains strong and our growth prospects remain significant. We have a well-defined strategy, a unique brand experience and a talented and dedicated team. Combined, these factors support my ongoing confidence of continued growth over the long term. Now, let me turn the call over to Mark to review our financial performance in more detail for the first quarter.

Mark J. Vendetti

Thanks, Neill, and good afternoon, everyone. My financial comments today are on an adjusted basis and I refer you to our press release issued earlier today for the details on those adjustments.

Total company net sales for the first quarter increased by 29% to $79 million. Overall, the company net sales increase was driven by 89 new boutiques opened since the end of the first quarter of fiscal '12, with 56 opened in the first quarter of 2013. Net sales in our direct-to-consumer business increased 97% with improvements in traffic, conversion and average transaction size. We opened 2 outlets in the first quarter, bringing our total to 3 outlets.

Comparable sales, including direct-to-consumer, were plus 2% on top of the prior year's plus 16% comparable sales, which has been restated to include direct-to-consumer sales. Please note, beginning with this quarter, we are reporting comparable sales including direct-to-consumer sales. Comparable sales excluding direct-to-consumer were flat to last year, below our expectation of a 4% to 5% increase. This decrease was driven by lower than expected transaction volume as a reflection of the unseasonal -- unseasonable weather conditions that persisted throughout the quarter. We've heard many retailers call out the negative impact of unseasonably cold weather on store traffic, and we were not immune to this trend. In reviewing our sales results by region, we saw variability in our comparable sales performance tied closely to the severity of unfavorable weather comparisons with boutiques in those regions of the country performing well below boutiques in parts of the country less affected by unfavorable weather. However, as we move into the second quarter, our 2-year stack comps trend improved in May and are above the first quarter's 2 years stack comp trend.

Regarding merchandise. Our best-performing categories were jewelry and nonseasonal accessories, with particular strength in necklaces, handbags and scarves. Gross profit as a percentage of sales declined 70 basis points to 52.4%. In response to sales trends and the aggressive promotional activity in the marketplace, we increased our promotions over the prior year period, which resulted in some gross margin pressure during the quarter. Promotions were used to maintain competitive relevance in a highly promotional environment and we're not required to clear inventory levels given our short lead time buying models. Adjusted selling, general and administrative expenses increased by 31% to $22.8 million compared to the prior year period of $17.4 million. As a percentage of net sales, adjusted SG&A increased 40 basis points to 28.8% of sales. The growth and adjusted SG&A expense was driven by an increase in the number of boutiques and operations during the first quarter of 2013 compared to the first quarter of 2012 and additional employees at the corporate office and infrastructure investments in technology to support the larger boutique base and direct-to-consumer sales growth. The majority of the deleverage occurred in selling expenses as selling payroll grew slightly faster than overall sales versus last year.

Adjusted income from operations for the quarter increased by 23% to $18.6 million, with an operating profit margin of 23.5% as compared to 24.7% in the prior year period. Adjusted net income increased 25% to $11.5 million or $0.26 per diluted share, compared to $9.2 million or $0.21 per diluted share in the prior year period.

Turning to the balance sheet. Total inventories at the end of the quarter increased by $5.7 million to $23.3 million, a 32% increase versus the prior year comparable quarter. Net of reserves, ending inventory was up 28% in line with sales growth and our inventories are well positioned as we head into the second quarter. We ended the quarter with $33.8 million in cash and cash equivalents, up from $8.2 million at the end of the prior year quarter and $29.9 million at the end of 2012. Our boutiques continue to deliver strong cash returns with four-wall boutique contributions in the mid-30% range and new boutiques return on invested capital greater than 150% in year 1. At the end of the first quarter, the company had a debt-free balance sheet.

As we look forward to the second quarter, we expect net sales to be between $94.5 million and $95.5 million, an increase of 24% to 25% over the prior year, assuming a 1- to 2-point comparable sales increase on top of a 21% comparable sales in the second quarter of last year. Additionally, we will open approximately 21 additional new boutiques during the quarter. Earlier, I mentioned the improvement in our 2-year stack comps in May versus the first quarter. In our second quarter comp guidance reflects a 2-year stack comp trend that is consistent with May business trends and above the first quarter 2-year stack trend. Adjusted net earnings per diluted share are expected to be in the range of $0.35 to $0.36, an increase of 21% to 24% over the second quarter 2012 adjusted earnings per diluted share of $0.29.

Moving to the full fiscal year 2013, keep in mind that fiscal year 2012 was a 53-week year. The incremental 53rd week in 2012 contributed $3.9 million in net sales and approximately $0.03 per diluted share in earnings. For the 2013 fiscal year, we continue to expect net sales to be in the range of $365 million to $370 million, an increase of 25% to 27% over the prior 52-week period in 2012. Comparable sales increases, including DTC are now expected to be in the 4% to 5% for 2013 fiscal year period. We expect comparable sales to improve in the second half of the year as we move into easier comparisons versus LY and beyond the weather impact of the first quarter and a very strong LY second quarter comp of 21%. We plan to open 85 new boutiques. Approximately half of the new boutiques will be mall-based and the remaining non-mall base. Adjusted net earnings per diluted share are expected to be in the range of $1.27 to $1.30. This is an increase of 22% to 25% over the 52-week prior year adjusted diluted earnings of $1.04. The number of diluted average shares outstanding is expected to be 44.9 million for both the second quarter and the full year. The effective tax rate is estimated to be 39.3% for the second quarter and the full year. Capital expenditures are planned in the range of $22 million to $25 million.

That concludes our prepared comments for the quarter, and we will now take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question will come from Jennifer Davis with Lazard Capital Markets.

Jennifer M. Davis - Lazard Capital Markets LLC, Research Division

My question is kind of on May comp trends and the delta between what you've seen or in the first quarter between as you said, some of the warmer weather climates that weren't as impacted by weather in some of the maybe, more the Northeast that, that was. Could you talk a little bit about maybe the delta that you saw between comps there? And we're hearing that May in general is pretty choppy and I assume that you're seeing that too, I know you've got the difficult compares but could you talk about maybe some of the differences in trends you're seeing in different regions in May?

Mark J. Vendetti

Jennifer, Mark here. I guess the simplest way for me to help you think about that is our 2-year stacked comp trend for Q1 was 18%. And with our guidance, we're guiding to a 2-year stack which would be 22% to 23%. So we, have on that basis, seen a good pick up in our May business and remain comfortable with the guidance for the quarter. I think that's the best way for me to address your question.

Jennifer M. Davis - Lazard Capital Markets LLC, Research Division

Okay. What about the kind of the delta between -- in the first quarter, between the warm weather stores and the cooler weather stores, I guess?

Neill P. Davis

Jennifer, it's Neill. That's a hard one to say. I mean, it was cool in Texas, it's cool in the North and the Southeast. It's very difficult to identify those variations down to a metric. One thing I would say to you is when we look at our mall-based locations versus non-mall-based, our mall-based stores actually performed better than non-mall-based and I basically look at that as reflection of those weather characteristics. So outside of that, it's hard to come up with a number. But suffice it to say, what Mark just articulated, we've moved to beyond those weather issues. We're seeing renewed strength and momentum in our clothing categories, particularly dresses. So we're coming into a more normal selling pattern and our customer's returning in the summer season.

Operator

And moving on, we'll go to Randy Konik with Jefferies.

Randal J. Konik - Jefferies & Company, Inc., Research Division

So, first, I have a question on just -- talk about top line and then talk about the gross margins. First, on the, I guess, with the fixed gross margins, based on the pattern you saw in the first quarter, it sounds like there's the confluence where the inventories are in the second quarter. Any color you can shed with us on how we should be thinking about go forward promotional levels from where we were in the first quarter and on a year-over-year basis? And then regarding the top line, if we go back to the first quarter when you gave -- and I think it's towards the middle to the end of March when you reported the fourth quarter results, and you gave the first quarter comp outlook of 4% to 5% and that was a miss, I'm assuming that there was a big drop off in April. And when we look out to the second quarter, comp expectation, I know you're saying that May sounds like it's fine but what kind of comparisons should we -- are we looking to go up against in June and July? Are those easier comparisons and so forth? Just want to get color to the level of confidence we have in that guidance number on the comp line for the second quarter.

Neill P. Davis

Randy, this is Neill. As it relates to gross margin and the potential promotional cadence, clearly we will be much less promotional as the weather dynamic subsides. We will be slightly more promotional and have been during Mother's Day and Memorial Day. And we may be leading back into the back to school season. But we currently think the overall competitive environment has eased somewhat. And as a result, our merchandise margins should be substantially similar to what they might have been in the prior year quarter.

As it relates to our visibility of business when we discussed our initial outlook to the first quarter, and I believe we indicated this on our call, we still have 75% of business in front of us. And trying to be weathermen, that's very difficult to gauge. So although we were somewhat late reporters, we did not have the full breadth of the impact of what weather meant to us particularly for the quarter. As it relates to your last question, the cadence within the quarter, I will tell you that May is our most difficult comparison in the prior year within the quarter. And it does get easier as we move into the current month of June and to July.

Operator

And next, from KeyBanc, we'll go to Edward Yruma.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

One question, one follow up. I guess, first, Neill, did you -- you characterized promotion at your end really just as a response to the environment and ones that weren't necessary. I guess from a higher level view, were they successful in getting the kind of returns or keeping you competitive relative to other folks in the mall? And then I guess second, in terms of some of the strategic initiatives you outlined, particularly with e-com and email tracking, things like that, how should we expect those to kind of flow through the P&L over time?

Neill P. Davis

Relative to the first question about did we get return on the effort, I mean, it certainly wasn't what we were hoping for but as the first person that asked a question on the call, it was Jennifer, with her perspective about how our results were worth for everyone else, maybe we did realize some benefit by taking that approach. But there were some promotional handles that we flexed in the quarter that underperformed our expectations. And the way I look at it is it gives us learning on the future periods as we move forward so that we can tighten up and once again, be sharp on those levers as we do pull them. As it relates to e-commerce, I'm going to ask you to clarify. I'm not sure whether you were asking about volume of business or relative profitability of business.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Actually, I'm was wondering from an expense perspective, obviously, these sound like kind of longer term investment processes. Are these systems you're planning to implement and how do we expect the expense piece of that as it flows through the P&L?

Neill P. Davis

Yes. About 2/3 of the capital that we're going to need to deploy and stand up systems that I referred to in my prepared remarks will be consumed this year and the following part will be consumed next year. The related depreciation of that spend will begin to be realized in 2014 because we really won't stand them all up until we get into early 2014. We're starting to add some payroll into the business in the back half of this year. So it's reflected in the numbers that Mark articulated for you and there will be follow on investments in 2014. And it's our expectation at this juncture that our need of incremental payroll would be complete in 2014. And just to be hopefully a little more clear for everybody else, in 2013, this year, we're making investments in parts of our business that are more aligned to our merchants. Next year, we will be making incremental investments that are more aligned to our DTC business. So that's how I would answer your question.

Operator

Next, we'll hear from Adrienne Tennant with Janney Capital Markets.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Neill, my first question is what gives you the confidence other than the easing 2-year stack comp comparison that comps can accelerate in the back half of the year? And specifically, is there anything non-promotionally that you can do, either marketing, reaching out to new customers to help drive that comp? And then for Mark, 2 quick questions. One is the 53rd week impact on the second quarter in sales or EPS or both, coming out obviously of the third quarter. And the second one is on the second quarter guidance, your earnings of $0.35 [ph] to $0.36 [ph] right in line with expectations on a slightly lower cost expectation, so I'm wondering where's the offset there? Is it gross margin, SG&A or opening more stores or a combination thereof?

Neill P. Davis

Adrienne, this is Neill. I'll tackle the first question relative to our confidence in terms of what we see for the second quarter and what is developing. Let me back up just a little bit and give some additional insight into our merchandise categories that might be helpful on answering that question and you interpreting where my confidence comes from. First off, half of our business is non-apparel driven. We are uniquely leveraged into some very fashion cycle-wide categories, specifically jewelry and certain elements of our accessories categories. So that's working to our advantage in the first quarter and it continues to work into the second quarter where we are today. The other element that really begins to turn the tide relates to our clothing offerings. Although it's only 50% of our business, within that category, we are very heavily geared or penetrated in terms of dresses. And dresses was the single category that was most challenged in the first quarter, particularly for the weather. Tops, bottoms, [indiscernible], all of our other categories were doing reasonably well. And we are beginning to see that turn in that part of our business and as a result, we're gaining a more robust, complete support of our assortment embedded in the numbers. And that's where the confidence comes from.

Mark J. Vendetti

So Adrienne on the 53rd week, the way to really adjust for the 53rd week in your models would be to just the week out of the fourth quarter. So it would only impact your fourth quarter and your total fiscal year. So it shouldn't really adjust your thinking on the second quarter at all. Regarding your second quarter just in terms of some general guidelines. Neill has alluded to we expect the gross margins to basically normalize and return to prior year levels. So I would assume that is a reasonable assumption for the remainder of the year and when it varies significantly on a quarter-by-quarter basis. So what you would really see that is, once you adjust that, there would be some slight leverage down in the G&A area for the quarter.

Operator

From Canaccord, we'll go to Laura Champine.

Laura A. Champine - Canaccord Genuity, Research Division

Neill, you mentioned rolling out a new enterprise platform. Can you tell us more about that and the timing of it and what exactly you'd like to do?

Neill P. Davis

Sure. It is the underlying engine that supports our web presence. We believe we need flexibility and stability as we move forward in becoming more personal in our communications and delivery of our product and experience to the customer in the digital space. And so, we will need to move to an enterprise platform. Essentially, what that means is we would change platforms or have a need to. So a better part of the current fiscal year would be involved in a selection -- identification and selection process. And begin the process of standing that up with a view of going live midpart of next year.

Laura A. Champine - Canaccord Genuity, Research Division

So is this a system that would be solely for the e-commerce or are we talking about a company-wide rollout of something along the lines of an SAP or Oracle-based system?

Neill P. Davis

No, no, no. When I say an enterprise solution, this is an e-com, direct-to-consumer platform only. It doesn't not -- it's not an SAP type application.

Operator

Next, we'll hear from John Kernan with Cowen.

John D. Kernan - Cowen and Company, LLC, Research Division

Can you just give us what the expectations for merch margin in both the second quarter and the remainder of the year are embedded in your guidance and what the expectations are for buying and occupancy leverage?

Mark J. Vendetti

Again, we do not guide on the merch margin aspect of it and I would basically again, go back to the discussion with Adrienne on kind of the gross profit margin. On the occupancy side, we generally say we realize leverage in occupancy when our comps are in the 3% to 4% range. So you can use that to help guide your projections for the second quarter and the balance of the year.

John D. Kernan - Cowen and Company, LLC, Research Division

Okay. And then can you talk just a little bit about your initial earnings? E-commerce side's obviously been updated, some of the initial learnings there and is there anything structurally that the boutique atmosphere -- between the boutique atmosphere and your brick-and-mortar that would stop this from becoming a more of a normalized percentage of your total sales mix relative to a lot of the specialty retailers?

Neill P. Davis

I haven't learned anything that would stop us from continuing to realize this pace that we're on. What she's beginning to do is become as equally excited about our nonparallel offerings as she has historically been of apparel. So the breath of our assortment is resonating with her. We're getting better everyday at imaging and messaging what that assortment is and she's seeing clear value of that assortment is. And as we add these subsystems to our platform, it's going to do nothing but enhance our level of communication and understanding. And keep in mind right now, we have not flexed at all, any meaningful search engine optimizations, search engine marketing programs to drive incremental traffic. A lot of the traffic increases that we're getting are coming to us organically or is through our e-mail campaigns. So there are a number of other levers that we are going to be pushing on [indiscernible] to drive that additional traffic. So it seems to be hitting on all cylinders and we have -- but I have to tell you, there's a lot of behind-the-scenes work to make sure that we are true to our boutique experience. As I know you see it in our physical presence, we feel very confident that we will be able to translate that experience, that feeling in a digital manner that's unique to Francesca's. So that's what you're going to be seeing coming in the next 12 to 18 months. Long winded answer to your question but hopefully, it gives you the color.

Operator

From Goldman Sachs, we'll go to Lindsey Drucker Mann.

Lindsay Drucker Mann - Goldman Sachs Group Inc., Research Division

A few quick ones for me. First of all, did you give -- I don't know if you did but if you didn't, can you give details on traffic versus conversion in terms of the composition of your comps for the quarter. And then secondly, can you talk about for the May acceleration, was that new product or how much of that was clearance product leftover from April and as the weather turned that you were able to push through?

Neill P. Davis

Lindsay, it's Neill. The question relative to the quality of our comp, I mean at the of brick-and-mortar level, we indicated that it was flat and all metrics were generally flat. Again, our business has been moving over the last several years in this quarter wasn't any different from transactions. And so, it was generally of a flat character. I mean, our business, as we moved into May, is not being driven by any outsized, extraordinary clearance flow through of markdown products. I mean, we have new receipts coming in, positioned for summer and she's responding to those.

Operator

And moving on, we'll hear from Howard Tubin with RBC Capital Markets.

Howard Tubin - RBC Capital Markets, LLC, Research Division

Maybe you can speak to what you're seeing out there on the real estate front that kind of what lead you to ramp up new store openings for this year?

Neill P. Davis

Howard. I wouldn't call 5 stores out of 80 a ramp up. What I have tried to do is to let you know that myself, along with the real estate team, always have a pipeline and we know where opportunities are. And when that team believes they can get the right positioning and the right economics, we have latitude to move. And that is exactly what you're generally seeing in our numbers going from 80 to 85. As example, one of those happens to be our new store in Manhattan, upper west side that comes on board in August. The real estate team and legal team did a great job of moving on that very quickly in less than 30 days. But it seemed like to me like 2 weeks. But in any event, when we see opportunities, we're going to respond quickly and that's all you're really seeing here. There's no real change in direction one way or the other. And quite frankly, as I think as you think about next fiscal year, think about 80-ish plus or minus. And that's the kind of number that we're moving towards and we're well into that type of number with the LOIs that we have on the table.

Operator

Next, we'll go to Janet Kloppenburg with JJK Research.

Janet Kloppenburg

I had a couple of questions. I was wondering if you felt that given the high productivity of the new stores, that perhaps, your comps were hurt by some cannibalization effect or even that the direct business perhaps cannibalized the store business to some extent. If you could talk a little bit about how you would measure that, that would be helpful. Also, Mark, I'm a little confused on your gross margin guidance. I think you're telling us it should be comparable to last year. I'm just wondering if you -- what happens on the occupancy line with the low single-digit comp? And from a merchandising question, I don't know if Sei Jin's on the phone or not, but I have heard that the dress business has been challenged or was challenged in the first quarter, maybe not just because of weather but something -- a secular change and I'm wondering if you're seeing that in some of your warmer weather markets and how you might be reacting to it.

Neill P. Davis

Janet, it's Neill. As it relates to your question of potential cannibalization from new boutiques and/or our direct channel offer or the others, the answer to that is no under both. A matter-of-fact, when we do size our boutiques and look at what potential volume might be, we do embed an expectation of some cannibalization and we have consistently and even this most recent quarter, experienced less than what we thought. So we continue to realize less than what might be appropriate in the market. And as it relates to the digital space potentially taking business from our brick-and-mortar, we're only 2 -- it's just 2% penetrated. So we've got a long way to go before that dynamic happens.

And I'll just jump in and answer that gross margin question. Mark was referring generally to the cadence year-over-year of our merchandise margin. So then, the variable to the full gross margin is going to be a reflection of comps leveraging and/or deleveraging depending on what your expectation is and therefore, the influence on the reporting number.

Janet Kloppenburg

Okay. And on the direct category?

Neill P. Davis

On the direct business. I don't see it. I mean, she's certainly responding now, but you're right, the first quarter was challenged. And I think we get exposed more to that challenge than most for the reason I mentioned earlier to an earlier question and that is that we're more heavily penetrated in that category than most. And so I did an outsized pressure but we've seen that turn back. As a matter fact, we're out doing some reorders as we speak to try to take advantage of some of that.

Operator

We'll go to Brian Tunick with JPMorgan.

Unknown Analyst

This is actually Vida Moyna [ph] for Brian today. We had a question on the long-term SG&A leverage. As you continue to add 20% for this growth, I was wondering why shouldn't we expect more normalized SG&A rates compared to I guess, other mall-based retailers in the mid-20s?

Neill P. Davis

Well, one of the reasons is that we're in a growth mode and we're building out infrastructure. As we move beyond that the next 3 years or so, then we'll begin to see that dynamic reflect in our numbers. But right now, we're in a growth mode.

Operator

We'll go to Liz Dunn with Macquarie.

Lizabeth Dunn - Macquarie Research

I'll just sort of ask a follow-up question. Do you have any data on what percent of your customer base online is your existing customer base, like pre-existing Francesca's customers?

Neill P. Davis

Yes. I think what I can tell you is yes, we do. And it's half and half. We're getting a very robust flow of new customers but we're getting a very robust repeat business from existing customers. So it's about 50-50.

Lizabeth Dunn - Macquarie Research

Okay. And then in terms of the last question -- actually, I'll follow up offline, we have to turn our phones off.

Operator

We'll hear from Richard Jaffe with Stifel.

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

Just a follow-on question for real estate. You talked about the outlet stores and having opened a couple more and I'm wondering if you have a take on the outlet center business for you guys and how that might play into the future?

Neill P. Davis

Richard, absolutely. First off, I think June is the -- we opened our first outlet a year ago in June. So we're just now anniversarying that, the full 12 months underneath our belt. And what we have seen out of that, we like. And what is that? We're getting a very meaningful lift to sales productivity out of that real estate type versus our mainline averages. Yes, there's a higher cost to it and, yes, there is more marked down clearance goods in it. But we're getting enough top line that is driving a nicely accretive expansion in profit dollars at the four-wall level. And as Mark said earlier, we're opening up 2 more this year and I suggest to you that as we get further into our planning for 2014, I don't know, 7 to 9, maybe 10 a year for the near-term would be a reasonable number for you to think about. But as we get more experience, we will adjust. But that's a good place for us to be.

Operator

And we'll go to Mark Montagna with Avondale Partners.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Just wanted to get a little bit more color on last year's Q2 comp. Sounds like May was the toughest month and then June and July get easier. But for those 2 months, is July the easiest of those 2 months? And then, the other question is, just dealing with the boutique remodels, how many are you looking to do, over what time period, and then what exactly are you doing with the remodel?

Neill P. Davis

Mark. The question relative to comp flow in the second quarter, it's largely similar. I mean, there's some variations but it's most pronounced in May in terms of the comparative. We're going to do 30 remodels this year and 75%, roughly, of our store base is 5 years old. So there's 25% of our store base that is working its way into a mix of needing to be refreshed. But I would submit to you that we're going to get more aggressive in our remodels because of the need to be on top of that boutique experience. We can always -- we're always honing ourselves to standards that improves over the prior year and prior periods. And one way to do that is refresh our boutiques. And so, we're going to get more aggressive in doing that and we've got plenty of capital and the returns still are dramatic, more than enough to justify the kind of spend that we would put into which remember, these are 1,300 square-foot stores, so we're not talking a big capital spend.

Mark K. Montagna - Avondale Partners, LLC, Research Division

So it sounds like you've clearly tested the remodels already and can you give us an idea as to how many stores you tested? And it sounds as you roll out stores, I would guess that you could probably finish remodels within a 36-month period?

Neill P. Davis

You know, the testing that -- if you're referring to testing I mentioned in my prepared remarks, these are separate prototypes. These are -- would be new boxes that might open up in a coastal region that would have a coastal flair versus someone that's in the middle part of the country that would have a different point of view and different flair. We're remodeling boutiques this year within that basket that I mentioned that are in these regions and that's where we're testing this. And quite frankly, it's not easy. It's not a go, no go. It is an editing process of what we want to go through to make sure we get the right presentation whether it's the lighting fixtures, whether it's color palette, it's that kind of thing. So, that's the testing and experimentation we're going through with the remodels right now.

Operator

That is all the time we have for questions. I'd like to turn the conference back over to management for any additional or concluding remarks.

Neill P. Davis

First off, I want to thank everybody for your continuing interest in Francesca's. We did have a tough first quarter but things have turned and Francesca's is geared for the long haul and we look forward to having our conversations and report our results for the second quarter in the next reporting period. Thank you.

Operator

And with that, ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your anticipation.

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