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Francesca’s Holdings (NASDAQ:FRAN)

Q1 2014 Results Earnings Conference Call

June 10, 2014, 8:30 a.m. ET

Executives

Randi Sonenshein – Vice President-Finance and Investor Relations

Neill Davis – President and Chief Executive Officer

Mark Vendetti – Senior Vice President and Chief Financial Officer

Analysts

Adrienne Tennant - Janney Capital Markets

Simeon Siegel - Nomura Securities

Brian Tunick - JPMorgan

Edward Yruma - KeyBanc Capital

Randy Konik - Jefferies

Pamela Quintiliano - SunTrust

John Kernan - Cowen & Company

Laura Champine - Canaccord

Richard Jaffe - Stifel

Janet Kloppenburg - JJK Research

Liz Dunn - Macquarie

Mark Montagna - Avondale Partners

Rebecca DuVal - Bluefin Research Partners

Howard Tubin - RBC Capital Markets

Susan Anderson - FBR Capital Markets

Stephen Marotta - C.L. King & Associates

Operator

Welcome to the Francesca's Holdings Corp first quarter 2014 earnings conference call. [Operator instructions.] I would now like to turn the conference over to Ms. Randi Sonenshein. Please go ahead, ma’am.

Randi Sonenshein

Welcome to Francesca's first quarter 2014 fiscal conference call. Earlier this morning, the company issued a press release outlining the financial and operating results for the first quarter ending May 3, 2014. 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 and fiscal 2014.

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 Davis

Thanks, Randi, and good morning, everyone. Sales growth this past quarter from our new and noncomparable boutique sales and direct to consumer initiatives contributed incremental total year over year growth of 16%. We opened 62 new boutiques this quarter, a record number, expanding our footprint to 513 locations nationwide, including five new outlets.

Our new boutiques have performed well thus far, especially our new outlets, and we expect new boutiques in 2014 will meet our thresholds for sales productivity, which is within 10% of chain productivity, return on invested capital in excess of 150% in the first year, and payback time at under one year.

It is important to note that our new boutiques continue to open stronger than the company average on a sales per square foot basis, are generating higher merchandise margins than comparable boutiques, driven by higher penetration of regular priced merchandise inventories, and this year’s vintage boutiques are opening with updated design elements that accentuate our apparel assortments and create a more vibrant boutique experience.

However, our comparable boutiques offset a significant amount of that growth with comps being down 7% in the quarter. Although we had expected this quarter to be challenging from a comparable sales perspective, the rate of decline was at the lower end of our expected ranges. This is the second consecutive quarter of decreasing comp sales and is reflective of comparatively difficult external conditions and the challenges of managing through those conditions.

From a merchandise standpoint, our apparel business improved markedly in April and May, as the weather turned warmer, and driven by strong customer response to our separates categories - kimonos, tanks, shorts, and unstructured bottoms, specifically.

However, that strength was constrained by underperformance in our dress assortment. Dresses have been declining in sales as customers are shopping more around peak seasonal periods, events, and special occasions.

Going into the year, we preplanned our spring assortments to heavily weigh our inventory into separates. Our initial read on February’s results shaped our trend thinking, with the dominance on separates but the broad trend developing into spring. That read was an overreach, as we have experienced stronger demand in seasonal and everyday dresses in the March and April timeframe. However, we could not respond quickly enough to the trend as our comp inventories were aligned to separates.

While the market had availability of dresses for us [to chase] we did not pursue, given inventory constraints. Adjustments have been made and we are seeing a gradual rebuild of dress inventory in late May and early June.

We do, however, have an opportunity to better align with the secular trends in dresses through our key buying periods, as she will invest for that special occasion. We have been active in testing elevated dress assortments across our boutique base, and are pleased with the initial sell throughs and future opportunity.

We continue to be impacted by the lack of a strong global trend in the jewelry category, and our shift to more metals and less color has been unfavorable for us in this past quarter. Jewelry constrained overall comparable sales by approximately 400 basis points in the first quarter.

That said, we did see jewelry statements begin to emerge toward the end of the first quarter, such as color framed and metal, novelty earring programs, and better material necklaces with higher retails, which we are actively chasing and expect will enable us to improve our business as we move through the year. We believe we can begin to start to deliver flat to positive jewelry comps starting in the third quarter.

Overall, the retail environment has been challenging since the beginning of the calendar year, with soft traffic trends and competitively aggressive promotions. The cumulative effect of these trends has limited the effectiveness of our merchandise clearance strategies, and has created bottlenecks in inventory flow for newness.

Our customer demographic trends respond best to well-edited assortments, newness, and lower price point items with a higher perceived value. Although motivated, she is not heavily interested in clearance. Even with our short lead times, we struggled to effectively clear during extended periods of slow traffic, and have limited space to maneuver from an inventory perspective.

Our overall inventory levels are within tolerances. However, the mix of slow-moving inventory is too elevated. To drive recovery top line trends, we are addressing this issue by aggressively moving out of slow-moving inventory in the second quarter, enabling an improved flow of new merchandise to boutiques to better satisfy customers’ demand.

We are actively chasing new styles, which began to arrive in early June. I want to remind you of my earlier comment concerning the relative margin profitability of our newer boutiques, being currently stronger than our comparable boutiques. And I do so to highlight our confidence of this recalibration of inventories within our comparable boutique portfolio for the balance of the year.

Relative to direct to consumer business, [DTC] sales grew 84% on top of last year’s 97% growth. This year’s gain was driven by both traffic and increased transaction size, as our initiatives to align the brand attributes across the digital space and our physical boutiques continued to evolve. We have been working diligently to elevate the online customer experience and will be relaunching both our website and mobile site over the summer.

The new site will feature larger images, improved navigation, and a cleaner, more brand-appropriate user interface and design. We’ll also be featuring user-generated visual content such as her wearing her favorite outfit or accessory from Francesca’s for a night out with friends, through integration with our social media content.

As we have discussed previously, in our efforts to improve customer engagement and further enhance our boutique experience, we reorganized our field leadership structure in the second half of last year. With this new structure in place, and ongoing refinements, we believe we’ll be better able to offer a more consistent boutique experience across our boutique base while maintaining the individuality of our boutiques.

Ultimately, we believe this, along with additional sales, service, and visual merchandise training, will foster an elevated customer experience and better position us to drive increased traffic conversion in our boutiques.

Now let me turn the call over to Mark to review our first quarter financials in more detail and provide second quarter and full year guidance. Then we’ll take your questions.

Mark Vendetti

Thanks, Neill, and good morning everyone. Total company net sales for the first quarter increased 8% to $85.4 million. This increase was driven by 97 new boutiques opened since the end of the first quarter fiscal year 2013, with 62 openings during the first fiscal quarter of 2014.

We ended the quarter with 513 boutiques. Comparable sales decreased 7%. The overall comparable sales decrease was driven entirely by a 7% decrease in comparable transaction counts and a flat average transaction size.

We had severe weather effects in the early part of the quarter, with February experiencing over 360 partial or full boutique closings, which we believe impacted comparable sales performance for the quarter by approximately 2 percentage points. Closures were broadly distributed across southern, northeast, and central geographic regions.

We saw our business strengthen in April, but not to the degree which would have delivered to the upper end of our guidance. Our April comp was positive, but would not have remained positive once adjusting for the estimated effect of the Easter shift.

During the first quarter, gross profit as a percentage of sales decreased 340 basis points to 49%, due to 160 basis points of deleveraging from fixed occupancy costs. In addition, merchandise margins were lower by 180 basis points, reflecting higher markdowns in clearance, particularly in February.

Selling, general, and admin expenses increased 19% to $27.8 million compared to SG&A of $23.4 million in the prior year period. As a percentage of net sales, SG&A was 32.6% versus an SG&A of 29.6% of sales in the prior year quarter due to 225 basis points of selling deleverage as a result of the negative comparable sales.

General and administrative deleverage of 75 basis points was driven by increases in the field leadership structure, which was initiated in the third quarter of 2013 and home office headcount primarily in our merchandising and information technology organizations.

Income from operations was $14 million, with operating profit margin of 16.4%, compared to income from operations of $18 million with an operating profit margin of 22.8% in the prior year 13-week period. Net income was $8.5 million or $0.20 per diluted share compared to adjusted net income of $10.9 million, or $0.24 per diluted share in the prior year period.

Turning to the balance sheet, total inventories at the end of the quarter increased by $5.4 million to $28.8 million. Ending inventory was flat on a per-boutique basis at the end of the quarter. We ended the quarter with $25.4 million in cash and cash equivalents compared to $33.8 million at the end of the first quarter 2013.

During the quarter, the company paid down $10 million of outstanding debt and has $15 million outstanding. Total liquidity at the end of Q1 was $110 million, comprised of $25 million of cash plus $85 million of revolving debt capacity, including $25 million of an upsized option.

During the quarter, the company repurchased approximately 300,000 shares of the company’s common stock for $5.3 million at an average price of $18.49.

Now turning to the second quarter and full year guidance, for the second quarter, we expect net sales to be between $98 million and $103 million, an increase of 9% to 15% over the prior year period. Comparable sales are expected to decrease in the range of a negative mid to low single digit number compared to a 1% comparable sales decrease in the second quarter of last year.

During the quarter, we plan to dispose of slow-moving inventory with a pretax cost of between $2.5 million and $3.5 million, which equates to $0.04 to $0.05 of EPS for the quarter. The inventory is composed primarily of clearance merchandise with a concentration in apparel and jewelry. We are taking this action during the quarter to accelerate the flow of new merchandise into our boutiques as we move into the second half of the year.

As a result of this action, and the continued promotional environment, we expect the merchandise margin to decrease 400 to 500 basis points during the quarter. Additionally, we plan to open approximately 16 new boutiques during the quarter, bringing our year to date total to 78 compared to 76 last year at the end of the second quarter.

Net earnings per diluted share are expected to be in the range of $0.24 to $0.29 compared to second quarter 2013 earnings per share of $0.33.

Moving to the fiscal year 2014, we now expect net sales to increase to $387 million to $399 million over the prior year, an increase of 14% to 17% over the prior year period. Comparable sales are expected to be in a range of low negative single digit to flat for 2014 compared to -2% for the 2013 fiscal year comparable sales.

We expect the back half of 2014 EPS growth to be stronger than the front half, given our expectation of comparable sales improvement in the back half of the year, particularly in jewelry and the lapping of investments made in the third and fourth quarters of 2013 based off our expanded field leadership structure and home office headcount.

In considering full year earnings, it is important to note that the quarterly earnings growth rate is affected by our expectation that the pace of selling, general, and administrative growth rates will decrease in the back half as compared to the front half of the year. We remain prudent, taking a disciplined approach to controlling expenses as we continue to see a difficult retail environment.

We expect relatively consistent merchandise margins in the back half as compared to the prior year. We plan to open approximately 85 new boutiques during the year and 60% of those will be mall-based. Within our non-mall-based openings, we have plans for 13 outlets. We plan to remodel approximately 50 boutiques during the fiscal year.

Net earnings per diluted share are now expected to be in the range of $1.05 to $1.17, which includes the $0.04 to $0.05 for the disposal of slow-moving inventory in the second quarter. This compares to our prior year diluted earnings of $1.02.

Capital expenditures for the full year are planned in the range of $25 million to $27 million. The number of average diluted shares for the full year assumed in guidance is expected to be 42.5 million, which excludes the potential impact of additional share repurchases during the year.

Our effective tax rate is estimated at 38.4%. This concludes our prepared comments for the quarter. We will now take your questions. Operator?

Question-and-Answer Session

Operator

[Operator instructions.] We’ll take our first question from Adrienne Tennant of Janney Capital Markets.

Adrienne Tennant - Janney Capital Markets

Neill, the comp trend improvement in the back half of the year, I was wondering if you could comment at all on quarter-to-date and does the comp guidance for Q2 suggest improvement in trend through June/July? And then for Mark, can you talk a little bit more about the disposal of inventory in the second quarter? Is that just markdowns/clearance? Or is there any thought about third party to get rid of some of that excess inventory. And are you cancelling any orders or making any changes to inventory commitments for the back half?

Neill Davis

Relative to trends in June/July, sequential trends versus that of May, I would tell you that there is some slight improvement, and it’s largely due to the seasonality of the business that begins to favor more of our clothing business. However, our jewelry business we would expect to be challenging for the second quarter. And as we look to the back half of the year, and as Mark said in his prepared remarks, our overall comp profile turns to an improving sequential trend to that of the first half, which is largely driven by our jewelry business.

I do want to point out, though, as you think about those sequential trends, also think about the two-year stack trends. We’re not expecting any material changes on a two-year stack basis first half versus second half. So largely, the second half improvement is, the heading is prior year comps that we crossed that time, that we don’t have to this time.

Mark Vendetti

Regarding the slow-moving inventory, I guess the answer is really yes and yes. By that I mean this is inventory that we’ve identified as slow-moving. Most of it is on clearance today, and we’re actively trying to move through it, but as part of the process during the second quarter, we will be removing the really slow-moving stuff off of the floor.

Some of that we may move through a secondary market [unintelligible], and some of that we just literally may dispose of. And you know, again, the idea is to get the really slow-moving stuff off the floor, so we can replace it with the merchandise we see selling better today.

Neill Davis

We’re not canceling orders. In fact, we’re increasing our pace as Mark and the merchants move forward and clearing the floor, as we described, our head merchants and the buyers are actively looking to backfill into those trends that are working for us, predominantly. As we walk into the seasonally important dress business and we’re seeing some initial reads that are good, and we are tracing back into more color that’s beginning to show up in jewelry.

Mark Vendetti

And just again, with the short lead times, we’re still highly open as we look at our third quarter business and totally open as we think about the fourth quarter business.

Adrienne Tennant - Janney Capital Markets

And then just lastly, any characteristics of the slow-moving inventory? Was it color? Was it apparel? Can you just characterize for us, what types of inventory it was?

Neill Davis

It’s largely seasonal. We try to move through some of the A seasonal business, and it’s just a bottleneck, so we just need to take it, move it, and move on, and drive our business with what is working.

Operator

Our next question comes from Simeon Siegel with Nomura.

Simeon Siegel - Nomura Securities

Can you help contextualize the Q1 and Q2 merchandise margin declines? How much of that pressure is due to the carryover you’re talking about versus just the promotional environment, versus maybe the product mix? And then Mark, what would the Q1 ending inventory increase have been, excluding that excess product?

Mark Vendetti

In the first quarter, our merchandise margin was down 180 basis points. There were really two key drivers within that. 50 basis points or so was really driven by a merchandise mix impact. Our jewelry margins are our strongest part of the business, and having that decrease as a percentage of sales impacted us by about 50 basis points.

The other large impact really is driven by the move to try to move through the clearance. So those are the two drivers, so 50 jewelry, and about 130 or so relative to clearance. As you think about the second quarter, the range we talked about, the net cost of the merchandise could be between $2.5 million to $3.5 million, so you could be up at 350 basis points on a range of our sales guidance.

We still expect it to be promotional and we’ve given some additional leeway as it relates to the promotions in the second quarter. And the size of the inventory, you’re talking slightly north of 10%, so our 28.8 could have been in a range of $25 million to $26 million at the end of the quarter.

Operator

Our next question comes from Brian Tunick with JPMorgan.

Brian Tunick - JPMorgan

Could you just go into greater detail on what you saw in the dress business in the quarter, and how we should think about it in light of the fast-turning model, maybe what fell short, and how we should think about the balance of product as the year progresses?

Neill Davis

It’s not that the business fell short, it’s that we leaned into and levered our buys to a more dominant separates and tops theme. We’ve talked about this before. The secular trends in dresses are beginning and have been favoring more occasional and special events as opposed to everyday, and dresses, outside of those special events and occasions, becoming more seasonal, which for us is largely a summer timeframe.

So we chose drive our investments to the categories that we have seen create some momentum from recent sequential trending, and in fact we might have been a little too heavy and biased toward that and missed some opportunities by not having more of a balance.

But our model tends to drive off of recent historical trending, and we drive to that. And right now, as we look to the summer and the balance of the year, we will balance out our investments to drive more of a seasonal mix. And as I said in my prepared remarks, continue to focus on being able to drive an assortment that is more elevated for those unique timeframes throughout the year.

And as I said, she is responsive to it, so I see some opportunities with stronger AURs and improved business as we reorient and recalibrate our business to capture as much of that business as we can, yet still be appropriately relevant - which we are - in our seasonal dress assortment during the summer periods.

Brian Tunick - JPMorgan

And then just one quick follow up. Can you just provide an update on where we are with the new field management structure? Maybe what are some of the returns that you’re seeing there, and how should we think about the margin contribution in the back half in light of the flat merchandise margin guidance in particular?

Neill Davis

Relative to the field organization and what we’re beginning to see, we put in place a field organization that has been built up as closer to the boutique four-wall management structure, specifically a district manager organization.

It creates a greater line of sight to the four walls, and then to the customer, and we’re beginning to gradually see improvements in terms of conversion as we are maturating that level of management hierarchy within the field. It’s an ongoing process. You just don’t hire it, put it in place, turn the light on, and expect it to happen.

It’s an evolving dynamic, and the progression that we have seen since making that decision into the current year, we are seeing benefits and as I alluded to in my prepared remarks, the benefits will manifest through better conversion of the traffic that we do have, which will show up in terms of our comps.

And again, it’s an evolving dynamic, and it will continue to build over the course of this year, and better position us longer term as we build out the organization and the business from a boutique standpoint.

Mark Vendetti

On the leverage for the comparisons in the back half of the year, the key elements of the structure were essentially put in place during Q3 of last year, so from a leverage perspective, that part of the P&L we’ll be able to leverage will be relatively flat year over year, Q3 this year against Q3 last year. And that will be the same thing in Q4 as well.

Operator

Our next question comes from Edward Yruma of KeyBanc.

Edward Yruma - KeyBanc Capital

On the inventory impact that you illustrated, I guess does that then imply that you’re selling it for below the cost basis, and thus this is an inventory writedown? And I guess what kind of broke down in your normal markdown process that would have disposed of this inventory [unintelligible] in-store clearance?

Neill Davis

We are not selling it below cost. We were selling at a very deep percentage off, and attempting to clear with that handle as we have historically done in the past, and with the actions that we’ve taken, and Mark talked about it in a little more detail, we’ll be moving to some explicit mark out of stocks and just then take it down below cost, which then gives rise to the impact to the P&L.

What broke down? Not that it broke down, but we’re operating in an environment that is significantly diminished in terms of top line traffic. Yeah, there are some dynamics in our business, specifically jewelry, that are giving rise to some of that, but we’ve talked about it, we’re making adjustments and responses to and moving forward. But we haven’t been in a slow traffic, slow top line environment, and with a small box format as we have, our maneuverability diminishes.

And so it’s realization and focusing on that, looking at what’s selling best. It is selling, it is working, but we’re constrained. So we’re taking an incremental effort to recalibrate so that we can rightsize where we are and clear some of that excess baggage over the last six months.

Edward Yruma - KeyBanc Capital

I believe jewelry was a 400 basis point impact last quarter. It sounds like it was this quarter. And I know you were consistent in saying that much of the improvement you’re planning for the back half is predicated on a jewelry improvement. I guess within those assumptions, have you moderated the inflection point or the growth rate of jewelry in the back half to kind of compensate for the weaker results you saw in Q1?

Neill Davis

The growth rate is moderated in the back half, and I’ll take you back to a comment I made on one of the earlier questions about the two-year stack trend. When you look at it on that basis, by quarter, by first half, second half, we’re not expecting any sequential trend changes. So it is largely an effort of focusing more on what we’re seeing develop in the market, which is, as I mentioned, color and better materials, and as we see that hit, it’s improving, and that will continue over the course of the year, but the big change first half second half is largely an easier compare.

Operator

Next we’ll hear from Randy Konik with Jefferies.

Randy Konik - Jefferies

In terms of the recent misses in the business, we didn’t have these misses before. Are you saying it’s just traffic, not a conversion issue? What is the exact issue there? And then does anything need to change in the supply chain to try and better react to these issues? Because as the company is getting bigger, the inventory issues are popping up more than in the past.

So I guess I’m just trying to get some perspective on how you’re thinking about the flexibility or inflexibility of the supply chain as you’re getting bigger. What’s been changing in the business from your perspective and why the small store format almost now, as you’re saying, works against you, because you don’t have the flexibility to kind of move things around or what have you. But yet you have short lead times. So I’m just trying to get a holistic response, how you think the business is morphing, changing, what needs to change, what doesn’t need to change?

Neill Davis

There was a lot in that question. I would tell you that it’s both traffic and conversion. And I think we all know what the traffic constraints have been, and that then leads to some conversion constraints, when our business is not fully geared to all the trends across all the categories that we offer.

Dresses are an example. So as you, on a secular basis, downturn in dresses, she’s focused elsewhere, and so we’re adjusting our business to be responsive to that, which we strongly believe that our business model and the characteristics of that allow for a continuation of being able to be nimble and responsive to those changes.

But nonetheless, recent history here, over the last six months in the back half of last year, we’re seeing some changes in the fashion cycle, and that’s impacting our conversion. We moved to a metal theme in terms of jewelry, and while it’s worked, it’s not been anywhere as strong as it used to be, when color was the dominant theme. Now we’re seeing that begin to turn, and turn more quickly, than we anticipated.

And I think once again, our model is unique and can be very responsive to those quick turns in the fashion business that is not necessarily possible with other kinds of business models that aren’t quite geared as short cycle as they are to the supply chain. You know, into the discussion of the supply chain, are there limitations? Actually, no. Our structure right now and the vendor base and supply chain that’s coming into the mix is being incremental to our ability to make all of these changes and adjustments that are necessary as the fashion evolves.

So we’re still very happy with and grounded in the supply chain. Those are some of the things I would offer to you around your first question.

And then the last thing I would just say, learning for the last six months and the back half of next year, what do we do on a go forward basis? We just become a little more conservative in our forward planning. That opens up more bandwidth for us to chase and be responsive to some of these changes that may occur and develop on a go forward basis.

Randy Konik - Jefferies

And then just to clarify, on the negative mid to low single digit comp guidance trend, is that just reflective of looking at a stack? Or is that reflective of thus far in the second quarter you’re tracking to that number?

Mark Vendetti

It’s what we’ve seen to date as we’ve moved through May and June. We’re near the lower end of the band, as we look at the first five-plus weeks.

Neill Davis

Of May. The outlook does not have June. And June/July are key months of the quarter - the peak summer season and then back to school. So they’ll be important for us.

Operator

Next we’ll hear from Pam Quintiliano of SunTrust.

Pamela Quintiliano - SunTrust

You mentioned the impact of weather. I’m just wondering if you can talk a little more about how the comps progressed throughout the quarter and if the more recent seasonal temperatures are inspiring the customer to shop. Also, can you talk about performance on- versus off-mall locations?

Neill Davis

Well, we clearly saw a dramatic shift in weather as we exited February into what’s referred to as Marpril, the combination of March and April, to reflect the calendar shift of Easter. And there’s no question that weather was a hindrance, and we saw it change dramatically.

Likewise, to your question, as we moved out of the first quarter into the second, the weather conditions, as I mentioned in some of my prepared remarks, I believe, have been favorable, and it’s really impacted our wrap business, specifically kimonos, which we just can’t keep on the shelves, and our shorts, likewise. So we’ve seen weather influence our business, and that’s what I would offer to you on that.

Mark Vendetti

And on the mall/non-mall, since we’ve moved beyond the difficult weather period, their performance has actually been very close to each other. No significant differences in performance.

Pamela Quintiliano - SunTrust

My next question is on jewelry. I know you’ve talked about it a little bit, but I’m wondering if you can remind us when the new jewelry arrived in stores, and if you could talk a little bit more about how the customer is responding to it.

Neill Davis

It’s a flow. We saw the business down trend in the second half of last year, and as our buyer began to assess developing trends and outlooks that began to favor more of a metal theme. And we began to flow the product in in the first quarter. And it continues to flow in. Silver and gold are good, and we’re complimenting that now with more colored metals and better materials, as I described. But what’s most interesting and exciting is the fact that it’s coming with higher retails, given the uniqueness and value with that. So it’s a flow. It’s not very hard, immediate floor resets like there might be in other retail businesses.

Pamela Quintiliano - SunTrust

Lastly, you mentioned problems with dresses. Can you just remind us how big a piece of the business dresses are, historically, and how quickly you can adjust that?

Neill Davis

The dress business, when you look at our overall business, is about a third of the apparel business. So it’s still generally within that range.

Operator

Next we’ll hear from John Kernan with Cowen & Company.

John Kernan - Cowen & Company

I was wondering if you could kind of walk us through the cadence of EPS growth in the second half of this year, if there’s any differences between Q3 and Q4. It looks like even the low end of guidance implies nearly 30% growth year over year. What is driving the higher end of that guidance? Is it mostly SG&A leverage? Is it some merchandise margin recapture from the jewelry business? Any insight into that would be great.

Mark Vendetti

There are three factors that drive the EPS growth. One is the top line, if you squeeze the back half and you think about our comp guidance, there’s an implied positive low single digit comp in the back half of the year, which will drive offline growth. We just talked about, on the merchandise side, margins being similar to last year in the Q3 and Q4. And then on the SG&A side, we will see a fairly large decrease in the year over year growth rate of the pure spend

So given our current expectations, we should see some leverage on the SG&A side as we move into the back part of the year. So those three elements combine to give it very strong back half EPS.

John Kernan - Cowen & Company

Could you also just remind us on the type of same-store sales growth that you need to leverage occupancy buying and selling expenses on an ongoing basis?

Mark Vendetti

It’s generally around a 3% range.

Operator

Next we’ll hear from Laura Champine with Canaccord.

Laura Champine - Canaccord

My question is, I know that you’re working to take inventories down, but I also know that you’re buying fresh inventories. When should we expect the inventory growth to be more in line with sales growth?

Neill Davis

On a comp basis, this recalibration will get us corrected, and as we look to making that adjustment for the second quarter and third quarter and fourth quarter, we’ll be cleaner, from a mix standpoint, and therefore expect us to be aligned in that regard, in that timeframe.

Laura Champine - Canaccord

So the question I’m asking is, total sales growth, when will that match total inventory growth closer? And I think the answer was the back half, but I just want to make sure I’m not misreading that.

Mark Vendetti

Yeah, back half of the year.

Operator

Our next question comes from Richard Jaffe of Stifel.

Richard Jaffe - Stifel

You talked about SG&A deleverage in the second half. Is that really going to be just comp driven as sales growth improves? Or is this some of the benefit of the reorganization and other initiatives you’re taking internally? And then just a second question, any key takeaways from what’s happened this spring in terms of product and merchandising? And is there a need, or are there initiatives internally, to make yourself more nimble faster, to react to slow turning jewelry categories or building up of dress inventory as we saw this quarter?

Neill Davis

Relative to the SG&A question and leverage in the back half of the year, as you said, we get back to some positive comps, and that begins to allow us to just generally leverage the overall structure. But it is accentuated by the anniversary of the field investment in the first half of this year, which would be a meaningful number on top of that. So those are the two dynamics.

And relative to takeaways being more nimble, what generally is happening, and quite frankly, I think our model works well to this, is that the trends have changed very fast. She has, and we’ve seen her, her being our customer, move from metals to color faster than what we have seen in the past. And I think our business and our supply chain and our approach is appropriately geared and managed and organized to be able to be as responsive as we can to those.

There’s really no change, other than just being top of mind to the trends, being responsive to it, being conservative as we go forward in thinking about our business, as I alluded to, to an earlier question, such that we possibly can be more responsive to those. But the fashion trends are changing faster now on us and it’s specifically within jewelry that’s happening, and I think we’re probably as uniquely responsive to it as we possibly can be.

Operator

Next we’ll hear from Janet Kloppenburg of JJK Research.

Janet Kloppenburg - JJK Research

I just needed a couple of points of clarification. I think your guidance for the year assumes that comps turn positive in the third and fourth quarter, but I wasn’t sure whether you had been that specific. And I was also wondering if inventory levels then would turn up. In other words, as your comps expectations improve, would the inventories per store then increase?

And also, I was just wondering, with respect to the trends changing faster than you had expected, and that’s an industry situation right now, are there any planning processes you can input to help you better lead those trends and react to them in a more timely, in-season manner?

Mark Vendetti

The implied guidance has the comp for both Q3 and Q4. They’re similar, but they’re a flattish to low single digit number, for both Q3 and Q4.

Janet Kloppenburg - JJK Research

Flattish plus low single digits? And what about the inventory?

Neill Davis

Relative to the inventories, our goal is to generally be within flat to slightly positive increase that’s aligned to comps. We’re most focused on the mix. I think we’re about as properly sized from a four-wall standpoint as we are. So it’s more quality and mix as opposed to the aggregate size.

And your last question, about are there things that we can do structurally to be able to be more responsive to trends, you know, one of the things we’re trying to do, and we’ve talked about this in the past, is again, to look to parts of our real estate portfolio to assist in our general clearance strategies, such that we can maintain that more productive mix. And we’ve got five outlets open now, targeted to have 13 for the full year. Those are being strategically positioned from a regional standpoint that can support our mainline boutiques and help us be more responsive.

But I think we read the trends as best as we can, as well as anyone else, and react to what we need to do better. And what we are focused in on is keeping the box available for our ability to be as responsive as we would like to be. But that’s an example.

Operator

Next we’ll hear from Liz Dunn of Macquarie.

Liz Dunn - Macquarie

I had a follow up to Janet’s question and some of the other questions that have been asked. You said you sort of leaned in and leveraged your buys to some of the changes that you were seeing on the fashion front. In a period like this, of rapidly changing fashion, why be aggressive at all? Why not sort of wade in instead of leaning in, and keep a little bit more open to buy?

I certainly understand that sometimes with things like jewelry, when the trend changes so rapidly and you have the excess, that’s sort of unavoidable, but a situation where you go too aggressively after a certain trend seems like something that doesn’t need to necessarily happen because you have such a responsive supply chain. You’re really not going to be caught short too often, unless you don’t have the open to buy. Could you just kind of address that a little bit?

Neill Davis

You know, our open to buy positions are still very healthy, as we look out going into the quarter, but I’ve got to be in business at some point in time. So we build into and feed into that, and close out the open to buy as we walk into the season. And we manage those trends and changes as best we possibly can.

So when we see that trend change as materially as it has in the first quarter relative to jewelry, can I get back into it within the first quarter, and impact the business? No. Can I make my changes and adjust the forward buying, because we’re still largely open in the second quarter? Yes.

So that’s what we’re doing. When I made a comment earlier about being generally conservative, it’s that low single digit comp profile that we’re looking to continue to fund, and we want to focus in on it the best we can. But we still keep a meaningful open to buy, and we’re trying to be responsive to trend changes and utilizing the open as best we can.

Operator

Next we’ll hear from Mark Montagna with Avondale Partners.

Mark Montagna - Avondale Partners

I’ve got two questions, one on the IMU and jewelry. Wondering if you are able to maintain your IMU, or is it possible that it’s being compressed a little bit from creeping costs from overseas manufacturing. And then regarding jewelry, I’m just a little bit confused on that. It sounds like the color jewelry that did so well for you in the past is not doing so well now, but then Neill, you had mentioned a couple of times during Q&A about some incoming color jewelry. Just trying to understand exactly how that differs from the past jewelry.

Neill Davis

Your first question, when you ask about IMU, are you referring to jewelry IMU?

Mark Montagna - Avondale Partners

No, the overall store.

Neill Davis

Our IMUs are strong and they’re improving. And what you’re seeing happen is more a mix shift dynamic that Mark referred to earlier, that might cause realization of IMU to change. As it relates to jewelry, the past, in terms of jewelry, was one color beads, as an example. Now it’s multicolor, and it’s grounded in metal.

So there’s a metal silhouette that’s got grounding in terms of color and that color is being grounded in better materials like glass as opposed to plastic. It really feels better from a value standpoint, and heavier, and she’s responsive to it. And that’s what we’re seeing her turn her attention to, and that’s what our buyers are end market sourcing to.

So it’s not an explicit color/noncolor, metal/nonmetal. There’s this middle ground that marries both of those dynamics together.

Operator

Our next question comes from Rebecca DuVal with Bluefin Research Partners.

Rebecca DuVal - Bluefin Research Partners

Obviously with traffic being a concern, I noticed that you growth were experimenting a little bit with new marketing ideas. You had the Mother’s Day event. How should we be thinking about your promotional activity as well as the marketing for the quarter? And then also, can you comment on the website and how that’s performing, and what kind of conversion you’re seeing on that? I know, Neill, you mentioned it briefly in your opening comments, but if you can give us a little more color on that, I’d appreciate it.

Neill Davis

Your first question, about marketing/promotions, the Mother’s Day event, which was more of a marketing effort, not a promotional event, is to highlight the boutiques during an event such as Mother’s Day, and create some energy around that, and be able to do it on an institutional basis. What you saw happen at one particular boutique, if you experienced that, was replicated across all 500 boutiques, not an insignificant effort to pull off. It was very well coordinated and planned and timed with our team here at home office and the field.

And we were pleased with the results. So you’ll see us continue to move forward with those types of events around those types of timeframes that better allow us to highlight the Francesca’s brand and what we’re all about from a local perspective.

As it relates to the website, our business, conversions continue to improve. It’s traffic, average ticket, and we’re getting some very strong results, as I did indicate in the prepared remarks. And I will tell you that a large part of that is coming from organic sources. She is looking for a dress or jewelry, or sandals, or something else, and she’s doing her own natural searches, and we’re showing up more and more in the SEO world. And our team is most focused right now to maximize the SEO dynamic and how we present ourselves on our website such that we capture and continue to capture incremental traffic on a go-forward basis.

So she’s there, and I think what our team is doing now will continue to allow us to draw and capture more traffic. And as I alluded to in my comments, I’m seeing significant traffic increases through our mobile site. So we want to mobile-ly optimize that presence right now, and you’ll see that develop in this quarter, towards the late July/August timeframe. But those are some of the initiatives that we’ve got going on that are driving our DTC business.

Rebecca DuVal - Bluefin Research Partners

And in terms of the promotional environment, are you planning, and is it built into your guidance, to keep up with more of an elevated promotional environment, knowing that traffic remains an issue?

Neill Davis

Yes, you’ll continue to see us do that, and we’ll try to drive the promotional dollars and investments to those categories that create the greatest value as we can, and it is the strongest productivity of our customer response to it than we’ve seen in the past. So yeah, we’ll continue.

Operator

Our next question comes Howard Tubin of RBC Capital Markets.

Howard Tubin - RBC Capital Markets

Maybe you can just update us on your thinking regarding share repurchases, given where the stock is. Are you still willing to go into your revolver to get more aggressive buying stock back?

Mark Vendetti

We have $40 million open on the current share authorization, and we’ll continue to evaluate our opportunities as the quarter continues to play out. And we’ll just continue to look at what’s going on in the market and make our calls from there.

Operator

We’ll take our next question from Susan Anderson with FBR Capital Markets.

Susan Anderson - FBR Capital Markets

I was wondering if you could maybe give a little bit more color on your thoughts around your promotional strategy. I’ve noticed a little bit of difference in terms of more promotions or even online flash sales. So are you looking to kind of maybe stray away from your typical BOGO promotion? And then also, if you could talk about if there’s been any difference in sales between age groups in terms of maybe more weakness with the younger consumer versus the older one.

Neill Davis

We’re trying to be more targeted in our promotional handles and that’s why you’ve been seeing more flash type profiles. And they have been productive, and we’ll continue to build and improve on those, not to the exclusion of our BOGO handles wrapped around our jewelry assortment, which has always received a pretty amount of good traffic and good attention and good value for her.

And of course it is certainly margin accretive to us, hence that remains our highest margin category within our overall mix. Did I capture what you were asking?

Susan Anderson - FBR Capital Markets

Yeah. And then just any color if there’s been difference in sales between the younger consumer and the older consumer.

Neill Davis

We don’t have a database that differentiates that today. It’s a future effort, but I don’t have that level of visibility down to age demographics.

Operator

Our next question comes from Stephen Marotta with C.L. King & Associates.

Stephen Marotta - C.L. King & Associates

Given the commentary early in the call, as well as comments within the press release, it sounds like the new stores are performing significantly better than the existing store base. Can you explain what that disparity might be the cause of?

Neill Davis

Well, they’re doing better than our boutique base. First and foremost, they’re new. Customers like new. Second, the store is level set with a full regular priced assortment. And thirdly, our newer boutiques have a more up tone, more updated look and feel from primarily a color palette perspective. So new, better in business and reg price, and better visibility or the physical attributes of the stores have improved, all of which are contributing to that.

Operator

That does conclude the Q&A portion of today’s call. I’d like to turn the conference back over to the speakers for any additional or closing remarks.

Neill Davis

I do want to thank everyone for your continuing interest in Francesca’s and our company, but I particularly want to thank all of the Francesca’s team members that may be on this call for their tireless commitment and hard work, as we are continuing to execute on our long term vision of building a unique and differentiated boutique experience. Their efforts make a very strong and significant impact on our results now and on a go forward basis, and I do want to thank them. And we will look forward to our call for next quarter. Thank you.

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Source: Francesca's Holdings' (FRAN) CEO Neill Davis on Q1 2014 Results - Earnings Call Transcript
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