Neill Davis - Chief Financial Officer, Executive Vice President and Treasurer
George Zimmer - Co-Founder and Executive Chairman of the Board
Douglas Ewert - Chief Executive officer, President and Director
Ken Dennard - Founder and Managing Partner
Betty Chen - Wedbush Securities Inc.
John Kernan - Cowen and Company, LLC
Brian Tunick - JP Morgan Chase & Co
The Men's Wearhouse (MW) Q2 2011 Earnings Call September 7, 2011 5:00 PM ET
Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to The Men's Wearhouse Second Quarter 2011 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, September 7, 2011. Now I'd like to turn the conference over to Ken Dennard with DRG&L. Please go ahead.
Thanks, Ted, and good afternoon, and welcome to The Men's Wearhouse Second Quarter 2011 Earnings Call. Today's call with management will cover a review of the second quarter results, outlook for the third quarter and an updated outlook for the full year of fiscal 2011 followed by a question-and-answer session.
Please note, we'll be making a number of forward-looking statements today, and all such statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions mentioned today due to a variety of factors that affect the company, including the risks specified in the most recently filed Form 10-Q and Form 10-K.
This call is copyrighted material of The Men's Wearhouse and cannot be rebroadcast without our expressed written consent.
Now I'd like to turn the call over to Mr. Neill Davis, Executive Vice President and Chief Financial Officer. Neill?
Thanks, Ken, and good afternoon, everyone. I will begin with an overview of the second quarter actual results then highlight our third quarter outlook, turn the call to Doug Ewert, President and CEO; and George Zimmer, Executive Chairman, before taking your questions.
Earlier today, we reported a total sales increase of 22.1% in the quarter. Our retail segment increased 10.1%, and the balance came from our corporate apparel segment. As it concerns our corporate apparel segment, I want to remind you the reason for the significant year-over-year growth in our corporate apparel sales is that we had yet to anniversary our acquisitions in the United Kingdom.
Our retail segment sales performance was driven by a 10.9% same-store sales growth rate at our core traditional Men's Wearhouse stores, which compared to the prior year quarter growth rate of 2.7%. This was driven primarily by higher average ticket conversion rates and secondarily an increase in store traffic, which offset a decrease in average unit retails.
Discount growth rate at Men's Wearhouse was diluted by our 6.2% comp growth rate in tuxedo rentals, and the tuxedo rental penetration at our Men's Wearhouse brand in the quarter was 34%.
At our K&G stores, we realized a 5.4% comp rate compared to the prior year quarter of a decrease of 4.6%, which was driven by higher average unit retails, as well as a higher average ticket conversion, while offsetting decrease in store traffic levels. And in our Canadian business, Moores, we realized a 4.4% comp rate due to higher average ticket conversion offsetting decreases at average unit retails and store traffic.
Before turning your attention to our outlook for the third quarter, I want to take you through a few details of financial results of the second quarter.
Our retail merchandise margins declined to 60 basis points. However, the decline was less than what we'd expected, and it was largely due to a higher mix of sales coming from tailored clothing, particularly sport coats and dress pants. In addition, we experienced significant leverage of fixed occupancy costs in the quarter of 144 basis points.
Rounding out our retail segment results is a comp sales increase in domestic tuxedo rental business of 6.2% versus a planned 6% to 7% range. In addition, we realized a higher tuxedo rental gross margin of 187 basis points as a percentage of related sales due primarily to lower per unit rental cost.
Gross margins from our corporate apparel segment in the quarter were 26% compared with 27.8% in the prior year. When compared to our retail segment margins of 49.7%, we experienced a material mix shift due to the acquisitions of Dimensions and Alexandra in the third quarter of fiscal 2010. Accordingly, that mix shift will continue to impact our results until third quarter when we anniversary that acquisition.
Adjusted selling, general and administrative expense in absolute dollars increased 15.9% over the prior year quarter. Adjusted SG&A related to the acquired U.K. operations resulted in a 7.6% increase. The remaining 8.3% increase is primarily due to increased payroll-related costs and variable costs associated with the increased sales.
So to recap our operating earnings performance, a 22.1% total net sales growth rate drove an 18.8% increase in gross profit dollars, which when coupled with significant operating expense leverage, produced a 26.5% growth rate in adjusted operating income. And as a percentage of sales, a 48 basis point increase to 13.9%.
From a balance sheet perspective, total inventories increased 30.3%. However, excluding inventory from our acquired U.K. operations, inventories increased 9.9% to support increased retail sales and planned promotions in the second half of fiscal 2011.
The company did not repurchase any shares of its common stock during the second quarter. However, we did repurchase 500,000 shares at an average cost of $29.98 per share subsequent to quarter end.
That wraps my summary comments on the second quarter, so let's turn to our third quarter and updated fiscal year financial outlook.
In our press release, the third quarter and full-year EPS guidance is provided on both a GAAP and an adjusted basis. My comments to you today will be to our adjusted current year expected results and adjusted restated prior year actuals.
We expect third quarter adjusted diluted earnings per share in a range of $0.64 to $0.66, which represents a 12% to 15% increase over the prior year quarter of 57% -- of $0.57, rather.
The key drivers of this earnings growth outlook is the continuation of improvements in comparable store sales in our retail apparel lines of business in Men's Wearhouse and K&G, driven by our marketing and merchandising strategies similar to that deployed in the first half of the year.
As it concerns our tuxedo rental business, we are now past the peak season for rentals and moving in to the seasonally slower second half. Our outlook for the second half of the fiscal year is for domestic comp rate in the low- to mid-single digit range with the third quarter flat to 1%, and the fourth quarter up low-double digits.
We have observed a general slowdown in the wedding industry as reflected in our forward reservation bill. However, we believe our market position continues to strengthen based on our growth rates in relationship of that at the industry as a whole.
From a gross margin perspective, we expect improvements year-over-year due to 3 key factors. First, we will anniversary our more aggressive promotional strategies in September, which will lead to a stabilization of year-over-year changes versus that experience in the first half of fiscal 2011. Second, we will also anniversary inventory markdowns at our K&G stores in last year's third quarter. And third, we will anniversary our acquisitions in the U.K., which was completed in August of 2010, thereby eliminating the negative impact to gross margins from a business segment mix shift.
We expect a mid-single digit increase in adjusted operating expenses, representing a modest deleverage as a percentage of sales in the third quarter, due primarily to the fact that we will have anniversaried our U.K. acquisitions and hence, as I just mentioned, eliminate the benefit of a lower operated cost segment to our consolidated expense rates as has been the case in the first half of the year.
Our updated outlook for the fiscal year calls for adjusted diluted earnings per share in the range of $2.13 to $2.20, which represents a 45% to 50% increase over adjusted diluted earnings per share for fiscal 2010 of $1.47. This is on top of the adjusted prior year growth rate of 31%.
That concludes my financial remarks, and I will now turn the call to Doug.
Thank you, Neill. As we reported earlier today, and as Neill went into with further detail, we produced a 32% increase in adjusted diluted earnings per share in the quarter, which was ahead of our expectations and brings our year-to-date adjusted diluted earnings per share to a 50% increase over the prior year. This strong performance is primarily a function of double-digit retail sales growth trends both in the quarter and year-to-date periods.
When we started the year, we had expected domestic comparable store sales growth of 5% for the first half of the fiscal year. However, we were able to exceed that expectation by a wide margin and produced a domestic comparable store sales gain in the first half of the year of 10%. The upside to our initial outlook was driven by a strength in our retail apparel lines of business as a result of our merchandising, specifically our aggressive promotional offerings and our event-driven marketing strategies that were initiated in the second half of last year.
Generating results such as these during times when domestic macroeconomic results are weak and the future tepid is a clear indicator to me that our strategies are on point. We will carry on with those strategies, making necessary adjustments along the way so we can continue to drive our business forward profitably.
I will focus the remainder of my comments on key factors that we believe will drive the earnings outlook that Neill has previously reviewed. Over the second half of fiscal 2011, we're looking for our domestic comparable store sales to increase in the low- to mid-single digit range, which represents a similar growth rate in both our retail apparel and tuxedo rental businesses.
When we consider our business trends on a 2-year stacked comparable store sales basis, this outlook includes a modest deceleration in our retail apparel business from a low-double digit range to a high-single digit range. However, it also includes an acceleration of our tuxedo rental business from a low-teens range to a high-teens range.
The modestly slower pace in our retail business is reflective of the stronger prior period growth rates as a result of the start of our promotional offerings initiated in September of last year, specifically over the Labor Day weekend. Our sales projections for the second half of fiscal 2011 are based on our actual quarter-to-date trends through this Labor Day.
I do want to highlight for you that although we are beginning to lap our elevated promotional posture in our Men's Wearhouse stores, our inventory positioning in the second half of this year will allow us to build on our recent successes in meeting our customer demands.
Why do I believe that? Well from the third quarter of last year through the first quarter of this year, we have been running a significant negative spread between sales and inventory growth rates, meaning our inventory growth was running significantly behind that of related sales. We believe that walking a conservative line as we began to evaluate the results of our BOGO strategy was appropriate at the time.
Beginning in the second quarter, we've made significant adjustments to better balance the spread between sales and inventory growth rates, based on the consistency of the positive response from our customers.
I should also mention that part of our increased inventory investment going into the back half of this year is related to operational enhancements we have initiated at the beginning of the third quarter. Specifically, we've now added functionality at the store's POS level for visibility into our e-commerce fulfillment distribution center. Our store personnel can now directly source from that inventory in order to satisfy individual customer demands that cannot be handled from an in-store stock. This will be done in one seamless transaction to the customer, with the ability for the shipping of those items directly to their home or back to the store, the latter at no charge.
Clearly, having a strong value message and being appropriately invested in the assortment is a key driver to our expected performance. However, fashion changes are also likely to impact our performance over the near and mid-term. Changes in fashion trends are expected to provide all of our divisions an opportunity to benefit from an inevitable replenishment cycle that could be quite significant.
For a few years now, luxury designers have been showing more flattering shape to their garments, including suppressed waists on suits, narrower lapels, narrow pants, slim-fitting shirts and narrow ties. These trends are now becoming much more widely accepted in the middle market, and currently represent only 15% of Men's Wearhouse inventory. We believe it could grow significantly higher as our customers update their wardrobes over the near and mid-term.
I want to touch on our tuxedo rental business for a moment. Although our forecasted trending on a 2-year basis in the second half of fiscal 2011 remains strong, it represents a slower pace trend than initially expected at the beginning of the year. Our market intelligence suggests that macroeconomic conditions are weighing on the younger consumer and its impact on the wedding industry, a key driver to our tuxedo rental business, is evident. However, our positive growth in the face of declining industry trends is a dynamic that we believe will continue in the near term, and our market share is expected to increase.
Additionally, we continue to pursue a number of avenues to drive growth through our existing retail brands, all of which are in varying stages of development.
The first and perhaps the most significant is big and tall. We've sold big and tall sizes for many years throughout all 3 of our retail divisions. Our big and tall business is now in excess of $350 million and is growing significantly faster than our regular size business. At Men's Wearhouse, the big and tall business is up 20% year-to-date, while regular sizes in the same categories have grown 12%. Similarly at K&G, this business is up 18% against a 6% increase in regular sizes.
Equally exciting is that this business is 300 basis points richer in margin than regular sizes. Previously, we announced we will be opening 3 big and tall test stores, 2 of which are now open.
It's too early to comment in any reliable way, but we're seeing a much higher sportswear penetration than we anticipated as well as suits. The purpose of these test stores is to deepen our understanding of the big and tall customer and to determine the viability of a subcategory spinoff from the full line Men's Wearhouse concept.
The second is store growth. In light of our positive results over the last 2 years, we've reassessed our domestic store penetration and now believe an expansion of our traditional Men's Wearhouse store base by approximately 18% from 591 stores to 700 stores is appropriate over the next 5 years. In addition, we're continuing to downsize our mall-based Men's Wearhouse and tux stores and are targeting a store base of 300 within 5 years.
That decision, which has been in process for the last several years, has led to a higher recapture rate of a close store rental volume and equally important, driving that traffic to a more fully retail inventory store has and is expected to continue to create opportunity for comp sales expansion.
The third area of opportunity is online. Our web sales are up 127% year-to-date, and we're continuing to make significant investments in both systems and people to position ourselves for even more meaningful growth in this channel.
In our last quarterly call, I discussed our approach to increased cost of raw materials and labor that could affect our clothing margin. That approach was based on a diversification in manufacturing resources, an increased private label merchandise assortment and implementing very selective retail pricing increases. I believe we are delivering on that expectation. In the second quarter, our retail apparel sales increased 12.4%, and our product gross profit increased 11.2%.
This year's third quarter will benefit from the adjustments we've made to our K&G brand at the beginning of the year. Last year's poor performance in our Designer Spotlight offering led to a worse-than-expected result in our women's margin. These offerings were ineffective and resulted in us having to clear unproductive merchandise at very low margin. Our ladies inventory is now in good shape. And as a result, we expect to realize a nice lift in the third quarter gross margins.
Our new corporate apparel business in the United Kingdom, which we have now owned for a year, is on plan. The integration of Dimensions and Alexandra continues to go well, and we remain optimistic about their combined future success.
In conclusion, I want to acknowledge all of the hard and effective work from our employees, most notably our store employees, who make our strategies work with our customers every day. Knowing they are all aligned, supports the confidence I have that we will continue to perform well in these very challenging times. Thanks to all of you for your interest in our company.
I will now turn the call over to our Founder and Executive Chairman, George Zimmer, and afterwards, we will open the call to your questions.
Thanks, Neill, and thanks, Doug. Well, I'm settling into my new role of Executive Chairman, and I must say it's reassuring to see how Doug and his team are performing despite the worldwide economic slowdown and uncertainty. These top line and bottom line results that we are reporting today are the product of this team's effort over the past 18 months. I couldn't be more pleased and impressed. As I've said, my personal focus remains on marketing and our corporate culture, as well as supporting Doug.
Before turning the call over to questions, I can't resist commenting on the growth of our National Suit Drive, which has so far netted approximately $2.2 million, triple last year's volume. Over the last month, we have received over 100,000 gently used clothing items from thousands of our customers and in return, we have given these customers a 50% discount coupon to purchase anything in our store.
These suits will now benefit men that are looking to return to the workforce who, otherwise, would not have had the means to purchase appropriate clothing. My point here is that doing good is good business. We will continue to look for these win-win opportunities, and I urge other business leaders to follow suit. Doug, Neill and I will now take your questions.
[Operator Instructions] Our first question comes from the line of Brian Tunick with JPMorgan.
Brian Tunick - JP Morgan Chase & Co
So first question, just trying to understand your comments I guess around the Labor Day results and I guess quarter-to-date guidance. Just trying to think through -- compare that to your inventory position, do you think sales were constrained from an inventory position? Or was there something else going on macro-related? Or was it tougher to anniversary last year's promo? And then the second question is then on the tux rental side, just more color on the forward bookings on the weddings side of it, was it just recent that things slow down? Or was there something happening a couple of months ago? And how do the gross margins in tuxedos continue to expand?
Brian, let me take a stab at these. There's a few things going on in our inventory. As we went through the BOGOs for the last year, we continually exceeded our sales expectations, and inventories came down more quickly than we had planned. We've now course corrected and believe that we have the right mix and the right quantity of inventory to get us through now this fall season. We have also increased our investment in big and tall inventory. And as you just heard, big and tall is a big engine for us right now. And we have also launched a new store web initiative, where our stores can access web inventory to supplement in-store sales transactions, so we built our inventories in the web space to support that initiative. As far as tux color, I would tell you that we instituted a number of changes this year and how we aggressively marketed this business. And we believe now that while those efforts were successful, that we have somewhat pulled some business forward and believe now that with the outlook we have on the back half of the year and the visibility we have into existing reservations in our system, that we're going to end this year in a mid-single digit overall comp profile for our tux business.
And Doug -- this is Neill, Brian. There is one other piece of color on the tuxedo rental business. If you recall in the comp number that Doug just gave to you for the back half of the year, it's very different from the third quarter and the fourth quarter. We once again are experiencing some shifts in our wedding rental business as it relates to uniqueness in the calendars. And particularly, in this case, the back half of the year, we're seeing a fair amount of reservation build for the date 11-11-11, meaning November 11 of 2011. And we're seeing a fair amount of business falling to the fourth quarter, and that's the reason for the variances in the comp rates that we gave to you earlier in the call.
And just so I don't feel ignored, Brian, I thought your first question suggested that we had an unsuccessful Labor Day because possibly of inventory shortages. And I think as Doug pointed out, our 2-year rolling comp is extraordinary, considering the incredible comp we had a year ago when we initiated our BOGO program.
Our next question is from the line of John Kernan, Cowen & Co.
John Kernan - Cowen and Company, LLC
Can you talk a little bit more about the merch margin that's embedded in your guidance in the back half? It seems like there should be some merch margin recovery given the current run rate and gross margin. And then I have a follow-up after that.
Yes. John, this is Neill. The gross margin profile clearly is much stronger in terms of year-over-year improvement in the third quarter. Again, that's because we're not incrementally promoting significantly more this year versus last year in our retail apparel business. And we're also realizing the benefits of the inventory adjustments at K&G that Doug referred to. So third quarter energy in terms of our gross profit margin is clearly there, and that will moderate down in the fourth quarter because of the lack of that benefit from that quarterly impact of K&G. So that's what I would offer to you on a gross margin perspective.
John Kernan - Cowen and Company, LLC
Okay. And then the outlook where you are on the back half of the year, I know you've left the BOGO promotion, is there some type of a mix shift that's bringing that down? I know you've raised prices on some items, just particularly in tailored clothing, but can talk about the outlook where you are, particular in Men's Warehouse for the back half of the year?
Yes. It's largely going to be dependent on the sell-through of the categories. But our AUR at the back half of this year can potentially be flat to up, as opposed to being down as it has been in the first half of the year because of the promotional cadences.
And obviously the increased ticketed prices will drive AUR a little bit.
John Kernan - Cowen and Company, LLC
Okay. And is there any way to quantify the shift from 9/10/11 that you've talked about on the last call in Q2 and also -- as well as in Q3 in the tuxedo business?
I haven't done that, John. It's -- remember the fourth quarter is -- we only do roughly 10% of our annual tuxedo volume in the fourth quarter. So really haven't fixated on that number, and that would require another conversation, as I have to look back at it. So I can't answer at this moment.
John Kernan - Cowen and Company, LLC
Okay. I was talking about the 9/10/11 shift, which I think was Q2 and then maybe affecting a little bit in Q3, but we can address that offline.
[Operator Instructions] Next question is from the line of Betty Chen with Wedbush Securities.
Betty Chen - Wedbush Securities Inc.
Doug, I was wondering if you can talk a little bit about the updated store potential you've just given for the Men's Wearhouse brand. I believe you now talk about 700 stores being the potential. Can you give us a sense of sort of what's new in that evaluation to get to that new number? And then also, what is sort of the store opening cadence we should look for this year in the upcoming years? And then secondarily, I had a question regarding raw material prices. You mentioned in the past that the team is very proactively, I think, hedged almost 50% of your wool needs in 2012. Given where wool prices are trending, do you feel that additional hedging may be needed or that you're comfortable with that strategy right now?
Betty, I would tell you that our thinking on our store count has evolved. There's a number of things going on. One, obviously, we're driving considerably more rental business in each one of our locations in recent years than in previous years. Also as our retail business is recovering nicely from the recession, it gives us increased opportunities for retail expansion. So for your purposes, I would think that if you thought of our store growth in the neighborhood of 25 stores a year, for the next few years that would be appropriate. As far as raw materials, we have seen a little bit of stabilization in some raw wool qualities, specifically within some of the micro-accounts that we buy high quantities in. We haven't seen the prices come down. What we're seeing is some stabilization. It's still priced considerably higher than where we have hedged, as you pointed out 50% of our wool needs for next year. We're comfortable with that position. At this point, I can't comment on whether we feel that we're going to do any incremental hedging. But at the moment, we're comfortable with our position.
Betty Chen - Wedbush Securities Inc.
And I had a quick follow-up, Doug. I mean the big and tall business is doing extremely well, and certainly, it sounds strategic to increase you inventory position there. Where do you think you might be gaining this customer or market share from, and where has he been shopping in the past? And where do you believe this segment could be a mix of overall sales, longer term?
Well there are a lot of retailers that carry various degrees of big and tall product. Department stores even carry some sizes that we classify as big and tall, going nowhere near as high up in the size range as we do. But there are a lot of retailers out there that carry varying degrees of big and tall product. But I believe that we are gaining some nice increases because of our increased inventory position. We've now started to more aggressively market the fact that we're in the big and tall business. We are now segmenting our e-mail, our customer database and targeting communications to our big and tall customers specifically. That's been something new this year. So there's been a lot of focus on our big and tall business that I think we're seeing some nice rewards from.
It appears at this time we have no further questions. I'd like to turn conference back over to management for closing remarks.
Well we appreciate your interest in our company, and we'll talk to you next quarter.
Thank you, sir. Ladies and gentlemen, this concludes the Men's Wearhouse Second Quarter 2011 Earnings Conference Call. If you'd like to listen to a replay of today's conference, please dial (303) 590-3030, using the access code of 4468052 followed by the #. ACT would like to thank you for your participation. You may now disconnect.