Call Start: 08:30
Call End: 09:39
Hudson's Bay Co. (OTC:HBAYF)
Q1 2016 Earnings Conference Call
June 10, 2016 08:30 ET
Elliot Grundmanis - IR
Richard Baker - Governor & Executive Chairman
Gerald Storch - CEO
Paul Beesley - CFO
Sabahat Khan - RBC Capital Markets
Mark Petrie - CIBC
David Hartley - Credit Suisse
Wayne Hood - BMO Capital
Patricia Baker - Scotiabank
Brian Morrison - TD Securities
Good day, ladies and gentlemen, and welcome to the Hudson's Bay Company presents the Q1 2016 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]
I would now like to introduce your host for today's conference call, Mr. Elliot Grundmanis. You may begin.
Good morning everyone, and thanks for joining us today. On behalf of Hudson's Bay Company, I would like to welcome all you to our first quarter conference call.
On the call today from here are Richard Baker, Governor and Executive Chairman; and Jerry Storch, Chief Executive Officer. With me in the arch is Paul Beesley, Chief Financial Officer. Yesterday we issued a news release on our first quarter results. We also posted complete financial statements to our website and filed them on sedar.com. In a moment I'll pass the call over to Richard, Jerry and Paul to make a few comments on our results, and then we'll open up the call to questions.
Before doing so, allow me to provide a disclaimer regarding forward-looking statements. Certain statements made during this conference call regarding HBC's current and future plans, expectations and intentions, results, levels of activities, performance goals or achievements, or any other future events or developments, including outlook for fiscal 2016 constitute forward-looking statements. Forward-looking statements are based on current estimates and assumptions made by management in light of its experience and perception of historical trends, current conditions and expected future developments, as well as other factors that management currently believes are appropriate and reasonable under circumstances. However, there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause HBC's actual results, levels of activities, performance goals or achievements, or future events or developments to differ materially from those expressed or implied by the forward-looking statements.
For a discussion of these factors, we refer you to the risk factors set forth in the company's annual information form dated April 28, 2016. As well as HBC's other public filings available on SEDAR at sedar.com and our own website, hbc.com. Listeners should not place undue reliance on forward-looking statements made on this call. Please note that unless otherwise stated all financial figures on this conference call will be expressed in Canadian dollars.
I would now like to pass the call over to Richard.
Thank you, Elliot, and good morning everyone. This quarter highlighted the benefits of our diversified flat door with retail operations open or under-development in six countries across ten banners. Despite a challenging retail environment in the United States, we saw strength in both Canada and Germany which helped to drive comparable sales growth of 2.3% at DSG and 0.7% at HBC, Europe.
Overall, sales increased by almost 60% with EBITDAR up $77 million compared to the prior year, primarily as a result of the addition of our European businesses. As always, the first quarter represents a small percentage of our annual earnings, especially when considering the impact of the joint ventures which we do not have at this time last year. We continue to execute our organic growth strategy, and a few weeks ago we announced that we will be bringing both, the Hudson's Bay and Saks Fifth Avenue OFF 5TH banners to The Netherlands. This expansion represents a great opportunity to take advantage of an underserved market while leveraging our existing infrastructure in Germany and Belgium. Over the next 24 months we plan to open upto 20 stores and have already announced the location of our first four which include both, the Hudson's Bay and OFF 5TH in Amsterdam.
The majority of the CapEx required for this expansion will be funded by our landlord, allowing HBC to focus its capital allocation on our other growth initiatives. We evaluate our real estate assets on an ongoing basis and subsequent to the end of the quarter, modify two of our Saks Fifth Avenue leases. In preparation for our planned flagships Saks Fifth Avenue store New Jersey at American Dream, we agreed to modify our Saks Fifth Avenue lease a the Short Hills Mall in New Jersey.
Additionally, we also made modifications to our Saks Fifth Avenue lease in Honolulu, Hawaii. These two lease modifications generated proceeds of $99 million for the company. We expect to receive the funds from these transactions during the third quarter of this fiscal year. These transactions highlight the significant financial flexibility that our valuable real estate portfolio continues to provide. Our real estate portfolio is less impacted by short-term trends in retail and we will continue to be opportunistic in how we leverage this portfolio to generate value for our shareholders.
I would now like to pass the call to Jerry who will provide a more detailed update on our retail priorities and initiatives during the quarter.
Thank you, Richard. During the first quarter we continue to make significant progress on our strategic priorities and initiatives. Despite the challenging retail environment we are excited about the opportunities that lie ahead. We continue to drive growth today while making prudent investments that we expect will drive profitability and growth in the back half for the year.
During the first quarter consolidated comparable stores sales declined by 1% on a constant currency basis driven primarily by weakness in their U.S. markets. The decline in retail tourism continues to impact U.S. sales which were further affected by weak U.S. domestic traffic, especially in the luxury retail sector. We benefited from our unique group of retail banners which are diversified across both geography and retail concepts. Our department store group performed extremely well, given market conditions, delivering comparable store sales growth of 2.3% on a constant currency basis. We also saw positive results from our European banners with comparable store sales HBC Europe up 7/10 of 1%.
Comparable sales at HBC off-price were down 4.1% during the quarter, large as a result of a revised pricing strategy if Saks OFF 5TH that was completed during the quarter. This target has shift towards offering a more consistent value proposition lead to a substantial reduction in overall promotional activity which drove the majority of decline in comparable store sales in this banner. In turn, realized gross margins at OFF 5TH were significantly higher compared to the prior year and we are pleased with the results and the resulting increase in profitability at OFF 5TH.
Digital sales continue to grow across all banners and were up 86% with the addition of Gilt. On a constant currency basis comparable digital sales were up 7.4% during the quarter. Go pleading mobile and personalization technology should ensure that we continue to gain further traction in this channel as we make ongoing improvements to both our systems and distribution network. As always, we are laser-focused on improving efficiencies and reducing expenses and are evaluating all aspects of our business to ensure that it's operating in the most efficient manner possible. In the last few months we've undertaken initiatives which we expect will enable us to be even more efficient going forward.
In the third quarter of fiscal 2015, we announced an initiative to reduce SG&A expenses through our North American operations realignment. We currently expect to meet or exceed our target of $75 million in annualized savings and realize approximately $28 million in savings related to this initiative during the quarter. Additionally, the company recently restructured the merchandise department of our European operations to ensure the most efficient processes are in place to support the growth for our European business. In North America, HBC also outsourced positions related to IT systems maintenance. We recorded total charges in the quarter of approximately $12 million, reports related to these two initiatives.
Annualized savings as a result of these initiatives are expected to be approximately $16 million which is an addition to the $75 million in savings related to HBC's North American operations realignment. We are currently evaluating other cost savings initiatives as we continue to focus on generating profitable growth. We continue to execute on our 2016 strategic priorities and initiatives and expect that our all channel model will drive growth. We've been investing in the business and we look forward to realizing the benefits of these investments in the coming quarters.
In Canada, we are seeing strong early results from our first two Saks OFF 5TH Stores and our first four OFF 5TH stores. We have announced a total of 8 more OFF 5TH locations in Canada and expect to see a similarly positive reception in these cities as well. We feel there is an unmet need in the Canadian market for a luxury off price retailer and our expansion of OFF 5TH is well positioned to fill that gap.
During the first quarter we also opened 8 new OFF 5TH stores in the U.S. highlighted by our first Manhattan location at 57th Street in Lexington. This location also has the first physical Gilt store within a store concept. Going forward we continue to see exciting opportunities for the expansion of its banner, both inside and outside of the U.S. In our digital business, we're working hard to ensure that all our North American banners are operating on the same platform. We're aiming to have Lord and Taylor, Saks and OFF 5TH on a common system by the end of this year which will improve our ability to implement changes across multiple banners.
In conjunction with this migration, we are improving our fulfillment capabilities through the installation of new robotic technology, the technology we first introduced in our distribution center in Toronto, which is scheduled to go live later this quarter. Following the Toronto implementation, we expect to roll out similar technology in our U.S. distribution centers. This improved technology for digital fulfillment will help us increase the speed of orders, improve utilization of the space in the distribution centers and reduce expenses associated with our online sales.
As we move into the second half of 2016, we feel confident that our ongoing efforts to become more efficient in conjunction with our all-channel strategy of combining exciting retail destinations with a best-in-class e-commerce platform will drive both sales and earnings growth. As you saw in our press release yesterday, we are confirming our guidance for 2016. We expect that the majority of our earnings will be weighted to the later part of the year in part due to the flat nature of the rent expenses associated with the joint ventures in comparison with the seasonality of the retail business.
I will now turn the call over to Paul to provide more detail of the first quarter financials. Paul?
Thanks a lot. Since Jerry has already discussed our top line results, I'll begin by highlighting gross profit, which was $1.383 billion during the quarter, a $529 million increase over the prior year's comparable [ph]. This increase in gross profit dollars was primarily related to the addition of HBC Europe.
On a comparable rate basis, gross profit as a percentage of consolidated retail sales increased by 70 basis points. I'd like to remind everyone that the cost structure in Europe is such that gross profit margins are higher than those seen in North America. This is in turn offset by a higher expense structure driven in part by higher labor costs. As a result, the corresponding gross profit in SG&A rates reported by HBC will not be directly comparable to historical results until later this year. Normalized SG&A expenses for the quarter were $1.3 billion, or 39.4% of retail sales, compared to 36.2% in the prior year. Normalized SG&A expenses increased primarily due to the additional rent paid to the joint ventures and the inclusion of HBC Europe.
Expense reduction is a constant focus at HBC. In this quarter, we realized total operating synergies of $28 million associated with the North American realignment initiative announced last year. Given the savings realized from this initiative so far, we expect to meet or exceed our target of $75 million in annual savings in 2016. As Jerry previously mentioned, we are continuously looking at ways to operate in a more efficient manner and believe that there are additional opportunities to leverage our scale to drive improvements in our cost structure beyond what we've already discussed.
Turning back now to our financial results, following the creation of the real estate joint ventures, we believe that adjusted EBITDAR best reflects the performance of the retail business. This metric provides the most consistent view of our retail performance, as it is not impacted by, among other things, HBC's ownership levels of the joint ventures and the resulting impact on net rents. This additional expense has a much more significant impact due to the seasonality of the retail business.
In the first quarter of 2016, the joint ventures had a $62 million impact on adjusted EBITDAR. These joint venture expenses are essentially flat over the course of the year. As I mentioned previously, the seasonality in the retail business is largely consistent across all of HBC's banners with sales and earnings weighted toward the back half of the year. As such, the impact of these expenses is much more significant in the first two quarters. While we expect -- while we believe that adjusted EBITDAR is useful in evaluating the retail performance of the business, we will continue to disclose this metric.
Adjusted EBITDAR for the fourth quarter was $251 million, compared to $174 million in the prior year. Adjusted EBITDAR as a percentage of retail sales was 7.6% in the fourth quarter compared to 8.4% in the prior year. Adjusted EBITDAR was $62 million during the quarter compared to $104 million in the prior year. Finally net loss was $97 million in the quarter compared to a loss of $49 million in the first quarter of fiscal 2015. Our normalized net loss in the period was $91 million, compared to a loss of $28 million in the prior year, mostly as a result of the addition of the joint ventures.
During the quarter, we sold a portion of our equity in HBS Global Properties for $50 million US, which had the impact of slightly reducing our ownership in this joint venture. This equity sale was done at the same valuation of our previous sale, which occurred toward the end of fiscal 2015. This highlights the fact that the value of our real estate is not meaningfully impacted by short-term trends in the real estate industry.
Going forward, we expect our real estate portfolio to provide the Company with significant financial flexibility. Based upon current trends in the overall retail industry environment and HBC's results so far in 2016, we are confirming our outlook for 2016, which has been provided in yesterday's press release.
Capital expenditures net of landlord incentives totaled $153 million during the quarter compared to $54 in the prior year. Major store growth initiatives during the quarter included the opening of HBC's first two Saks Fifth Avenue stores in Canada, the remodeling of the third and fourth floors of the Saks Fifth Avenue Flagship in Manhattan and ongoing work on our new Brookfield Place and Hawaii Saks stores scheduled to open later this year.
Work also began on the installation of an automated fulfillment technology at the Company's distribution center in Toronto and is proceeding smoothly. We continue to expect capital expenditures in fiscal 2016 to be between $750 million and $850 million, with approximately 70% of this related to growth expenditures. Please see our first quarter MD&A for a full breakdown of our capital guidance.
I'll now turn the call back to Richard.
Thank you, Paul. Based upon the progress and momentum of our strategic priorities initiatives as well as our performance during the first quarter of fiscal 2016, we remain confident in our ability to execute on our strategic plan as we head into the second half of the year. As always, I'd like to thank all of our associates for their hard work so far this year as we work toward becoming a world-class retailer. Operator, we are now ready for questions.
[Operator Instructions] Our first question comes from Sabahat Khan from RBC Capital Markets.
Thanks. Just on the -- you mentioned the strategy change that's leading to lower comps and potentially better margins. Can you maybe talk about the thought process behind the shift and, as you make that transition, should we expect negative comps for a few more quarters as you change over? Thanks.
Great question. And when we announced our same store sales a few weeks ago, I know people were looking at that number, and I wish we could have answered at that time and now we can. We're pleased with the profitability at Saks OFF 5TH and the change in the pricing strategy is working exactly as we had hoped it would.
And the former strategy, to remind those of you who may not be versed in it, was that we would have a market price on the ticket for the goods, which is what it would sell out, for example, at a department store, then we would have our price, which was what we would sell it at in any given day and then we would run promotional events with an additional 30% or 40% off that intermediate price. And these were very common, it would run over holiday weekends, things like that.
The net effect of that it was very difficult for consumers to figure out what the price actually was. It also meant our merchants could not be precise in their targeting of prices. They had to take the same 40% off, for example, on a big weekend, of something they knew they didn't even have to put on sale in order to sell as they did on something that might be -- might require the 40% off to actually move. So we moved to more traditional off-price style of pricing, which is where there's the market price shown on the ticket, which again is what it might sell at a department store, and then there's our price every day, which is the off-price price, the fully discounted price of the object, and our merchants were able to price each item individually in that manner.
The impact of this is we did not -- we lost the promotional spikes we've been getting on some of the big holiday weekends, for example, but in return, we got a substantial increase and our gross margin rate, the type that you kind of hope for as a merchant in your career really see and that's translated in improvement of overall profitability. Given the year-over-year comparisons, we were up by I believe around 10% in the first quarter last year after tax and 12% the second quarter but hen as we started to phase in the pricing and started to test in some categories we were up much less for the third and fourth quarter like 2.5% or something of that approximate zone.
So as we get to the third quarter we will be comping that much lower number from the prior year and we would expect to ride nicely on top of that. So that's about when you should start to see a change in the comp level but meanwhile I just want to emphasize the profitability is enhanced by this move and we are quite pleased with what we have seen in terms of our merchants have learned the process and consumer as they are now shopping more frequently in the non-promotional days and the gross margin with this is much higher overall.
Alright, thanks. And then on the stocks full line business you commented on the challenging trends there, can you maybe talk what you are seeing specifically on the ground? Is there still international tourist, when you think that might turn? And then second part of the question is as you do renovations there, are the sales trending like in the similar in some of the Hudson Bay stores and a bit on how far along the renovations are?
So first, we think the first part of your question, it's obvious that those who follow retail industry that the luxury market particularly in the United States but not exclusively so is stressed quite significantly and we have seen results from the people in the industry that are quite low and we know from our context that there has been a very difficult market particularly in the gateway cities. This has been heavily driven by the abandonment of the market from international tourist, so that continues but we are starting to comp against when it began last year so we started seeing a big decline in international visitors in the United States in the first quarter of last year and we are starting to comp against that.
You know, really starting to dive later in the year so you almost reach a point where there is not many of them left to no longer come and so we are focused on the domestic business and growing that so there is some reason for optimism there. I don't want to exaggerate. It feels a little better than it did before and we think it might well get better as we get to the back half of the year because, principally because of the easier comparison year-over-year. Meanwhile in terms of the second part of the question, I want to highlight that on the way, we are getting a benefit in Canada with exchange rate pressure so our largest visitors to United States turns out to be Canadians and we are fortunate in that we are diversified in that sense we are seeing nice business in Canada.
As the Canadians in essence are kind of trapped there in doing their purchasing in Canada and are Saks Fifth with avenue stores in opening Canada are doing amazing. And we opened up the Queen Street store right adjacent Hudson Bay Store, both stores are forecast, not just the new Saks Fifth Avenue Store one of the best openings in our history on the Queen Street but also the Hudson Bay store saw a nice increase in its sales particularly in the home department its customers couldn't shop home at Saks. We don't have home department at Saks but we are cross shopping the stores quite nicely there so the Canadians are staying and buying there. We see that in our Hudson Bay business and also the Saks on Fifth which has opened very strongly in Canada, so the currency is kind of behaving almost as you would expect it to in various markets.
In regards to the renovations, we are seeing nice numbers, I highlight our Houston store where we did a significant renovation and relocation of the same center and that store has flown by our expectations as well as doing quite nicely in that market place so we believe that we have renovated enough for these stores to have a high degree of predictability in regards to capital investments on the renovations and we will continue to see those kinds of lifts as we make these buildings more exciting destinations, real experiences providing people exactly what everyone says department stores need in this environment which is an exciting retail destination and we are getting the benefit of that.
Alright, thanks. And just one last one for me, you provided some commentary in the press release on the inventory position, can you maybe give some commentary on your comfort level with inventory and the type of products you are holding coming out of the quarter was the best achievement to the warm weather stuff?
I'll start with that and let Paul add on. We believe our inventory levels are on-track, we feel good about them, the primary reasons for increase in year-over-year inventory levels, I will remind our first because we now own top of Gilt saw additional businesses that bring with them significant additional inventory and the exchange rates are also another reason that come into play. The principle reasons for the increase in inventory. We have been, we did end the year a little heavier than we wanted to go back to the end of last year and we are making significant progress on reducing those inventory so if you look at it will also remove the comp store inventories, from the, if you look at those because we have added a significant number of new stores in Saks OFF 5TH and some new Saks openings, I think we feel quite good about our inventory situation as we get ready to turn the corner at midpoint in the year. And by the end of the second quarter I think we will feel that we have done a great job in the inventories exactly where we wanted them to enter the second half of the year. Paul I don't know if you have more commentary on inventories?
No, I would just reiterate the comp off, FX, Gilt and bit of higher inventory in the Saks towards the end of the quarter. The team has done a great job on managing that and we expect to be coming out of Q2.
And I would say from most of our competitors what I can tell, we are being very conservative in planning inventory for the back half of the year and you can see this. People say they are doing that publicly, they say that privately. Also when you look at the actual shipments from overseas, you see a significant reduction year-over-year in things like the Baltic Dry Index and other indicators of actual imports in the U.S. That's one of the reasons why we believe the second half of this year by the way might be considerably better overall from the first half is that most retails are playing this very conservatively and we won't have kind of excess inventories that characterize last holiday season.
Okay great, thanks.
Our next question comes from Oliver Chen from Cowen & Company.
Hi, this is Sila [ph] in for Oliver. Thank you for taking my question. We were hoping if you could talk a little bit more about your online business and the Gilt integration. It was really nice to see that strong push this quarter. I understand that reflects the acquisition of Gilt but would the contemplation of Gilt inline or perhaps slightly better than what you are expecting?
We are pleased with the integration of Gilt, it's going very well. We are learning a lot from each other keeping in mind we first took possession of this business on February 1, so its brand new and we couldn't really make a lot of changes and in the first quarter that we moved as rapidly as we could, start taking returns in Saks OFF 5TH stores to stores we have a store array at of 57th Street location and generally to liberalize returns at Gilt by the way. As we look at the business we see a lot of room for improvement. A lot of opportunities to capture synergies in our business and their business and so we are feeling very good about that. The teams are working well together, the organizational consolidation has gone well so it looks very positive.
I would say we have got some questions about the comparable store sales increase in our internet business and I wanted to assure you, to remove Gilt from the numbers that we would still be growing our base internet business if you will at double digit rates. And Gilt when it came to us was not growing at the same rate we were and it's going to take us a while to get them going where we want them to be but we are confident we can do that.
Our next question comes from Mark Petrie from CIBC.
Hey, good morning. I just wanted to ask if you could clarify a little bit more on the nature of transactions in New Jersey and Hawaii on the Saks stores. Are those stores closing or is this simply driven by the development activity that you are undertaking in those markets and what is the nature of the change in those stores?
Well, as we have been talking for a long time, we are planning on opening a flagship Saks Fifth Avenue store at American Dream, so it's part of preparing for that we last year closed our brilliant [ph] location and we are planning on exiting out of Short Hill in order to relocate our business and build a much more vibrant branded prototype Saks Fifth Avenue store at American Dream. And then Hawaii, as we were getting prepared for our grand opening in August the landlord worked with us on some modifications that worked out advantageous to both of us. That store will be opening in August.
Okay. And then just stepping back and acknowledging, expect conditions and results to improve through the back half of the year but is there a point where you become concerned about the rent burden and where are you comfortable with rent as a percentage of your EBITDAR?
To respond to the first half of your question, we're not concerned about the rent but they are flat across the year and so that did have an effect which I think was one that some analysts and others didn't fully forecast but did have an effect on the first quarter, the lighter quarter, like that of impacting the EBITDA or that income more highly than it would in the fourth quarter, for example. The rents are the same every quarter but the sales are significantly seasonal and the gross margins are significantly seasonal, leading to the effect that you saw in the first quarter, but we're not concerned about the rents and we know what they are and those are included in our forecasts for the year and our guidance and our planning for the year.
And remember we own large percentages of the landlords, which in most cases are the beneficiary of the rents. I would just add that during the quarter, rents to third parties and net cash rent to the JVs were approximately 6% of sales and that's a level we're very comfortable with.
I'm less interested in Q1 and just more broadly about how you think about the business. Do you think there's an opportunity of that rent as a percentage of EBITDAR to move up or are you hoping that it goes down, or how should we think about that?
The rent as a percentage of EBITDAR obviously rent's not included in EBITDAR, and in EBITDA the rent would only go up to the extent that we sell additional portions of the joint venture, and when we do that, that does affect EBITDA. That's one of the reasons that we sold $50 million in the quarter to Madison. That doesn't impact EBITDAR but does affect EBITDA. We get the $50 million, but it does take some of the EBITDA and transfer it to the partner who bought that stake in the joint venture. This kind of thing is why we continue to underscore that if you want to analyze trends in the business, you need to look at EBITDAR because it won't be comparable year-over-year to look at EBITDA as various things happen with the joint ventures.
Okay. And then, understanding that there is some pretty significant shifts in the business mix that impacted gross profit rate, could you give us a sense of gross profit rates in your various units, I mean, not specifics, I understand you don't want to get into that level of detail but maybe just broad strokes outside of the impact of HBC Europe.
Yes, sure, great question. Gross margin rate definitely improved at Saks OFF 5TH, as I said, significantly improved at Saks OFF 5TH, and in the other North American businesses, there was some pressure on gross margin rate and that reflects the overall promotional environment in the market at this time. And, again, as we get to the back half of the year for some of the reasons I've already articulated, we think that that won't be the same as what we saw. Everyone ended the year, our competitors as well as us, in a heavy inventory position and had to do a lot of work to get that liquidated in the first half of the year and all of us are going to have a lot of mud on our face if it doesn't get better in the second half of the year after we all talked about the weather as an impact last year, and I do think it was a spectacularly warm Christmas season last year so it will be interesting to see what happens this year. But we have no reason to believe it will be that hot again. So that's kind of the general sense of how that should play out.
What about Canada?
We don't talk on detailed levels there, but there's not nearly the pressure as we saw in the United States.
Okay. Thank you very much.
Our next question comes from David Hartley at Credit Suisse.
Yes, thanks, good morning. I just want to talk a bit about some of the interesting things that are happening over at your different banners. Maybe you can take us through anecdotally some of the gains you're seeing by putting Gilt and OFF 5TH together, where you're really seeing opportunities that maybe you didn't expect at the Saks new store openings. And if you could also maybe comment on how things are proceeding with the renovations on the Saks store OFF Fifth Avenue, I know you've made some commentary in your remarks today but if you could expand on that. And then just finally on the Lord & Taylor building OFF Fifth Avenue. Can you give us an update on what your thinking is there in terms of that building?
Let me start with the questions about Gilt and then Richard will discuss the Saks OFF 5TH flagship and Lord & Taylor flagship. So in regards to Gilt, we continue to see more opportunities for synergy vis-à-vis the Gilt business itself. The first quarter was a good quarter for us and we were happy with what happened there and are more than meeting our acquisition model and planning for that. And the business had -- it is a fabulous brand but as they got closer to the sale process, they were clearly somewhat stressed in cash flow and otherwise, and they had been making some business decisions that were more short-term oriented than long-term oriented and we were able to change those immediately upon acquiring the business. So we're excited about what the impact will be going forward on the Gilt business itself as we do that.
Meanwhile, one of the biggest benefits to the acquisition was their terrific development team, both in the United States and Ireland, and we've begun to utilize them quite heavily for other banners with their skill in personalization and mobile technology, so they're leading the way in improving the personalization, for example, on the Saks Fifth Avenue website. And additionally they're developing the mobile application for our business, just to show you some of the scope with which they're helping us. And I think, as you know, we're strong believers in the Internet and the all-channel retail model. And we don't want to be second to anyone on the Internet. And so this acquisition is bearing fruit on both the immediate off-price business side as well as on the Internet development side with their expertise. So Richard, do you want to talk about the flagship stores?
Sure. We're making good progress at Saks on Fifth Avenue. We'll be opening up the fourth floor totally renovated in September. The team did a fantastic job keeping control of the business during renovation. So we saw little to no impact having the entire fourth floor closed, which is really great as we continue on our several-year renovation and phasing of that building. Next year or the second half of this year into next year, we'll be doing additional work on the third and second floor in that particular building. At the Lord & Taylor building on 39th and 5th, so far floor we've renovated the first floor, the second floor, the third floor, the ninth floor, and the tenth floor, and we are working on plans to continue that building. Additionally, as we relocate our office space downtown, that frees up a great deal of underutilized space within that building that was used for office and unlocks a lot of value that we expect to be taking advantage of, going forward.
And Jerry, if I can follow up just on one of the advantages of putting Gilt with OFF 5TH was the question around returns and the ability to kind of facilitate that better and turn that into cash, I guess, and more sales, how have you -- it's early, but are you seeing that hitting where you'd expect it to be or do we need to comment on that at a later time?
I think we're seeing the customer response to that has been good. There's still some system changes we need to make in order to make that inventory optimally usable, with returns to the Saks OFF 5TH store, because frankly right now, we're taking it in the Saks OFF 5TH store and sending it back to Gilt, back to the distribution center to recycle it. In the future, we want to put it right on the floor at Saks OFF 5TH and we're not able to do that until another month or two from now, but very soon. A lot of the changes we want to make to integrate Saks OFF 5TH and Gilt requires system changes of that ilk in order to accomplish them and a big bulk of that, when I look at the development schedule and I've met with the team, it looks like we'll have a lot of that done in the third quarter and in time for the back half of the year, so it's another reason for optimism for the back half of the year.
Great. And then Paul, if I could just finish up by asking you a modeling question, really, just thinking about free cash flow or use of cash this year and where you think we'll end up on a net debt to EBITDA basis at the end of the year?
It will probably be flat. You know one thing I would like to highlight is value of our real estate so we have discussed the $99 million and if you think about it we were able to reallocate capital in a very efficient way and if we're certainly mindful of the cash flow position, we got our capital program which we have gone into details on but we expect to be flat at the end of the year.
You are talking about net debt to leverage right?
Okay, great. Thanks a lot.
Yes, the other thing I would like to highlight, I don't think Paul mentioned it is we have an additional focus on working capital management which where we believe we have significant room for improvement particularly in terms of improving our turns and this is major focus across each of our business units and we expect that bit to start bearing fruit this year.
Great, that's very helpful. Thank you, Jerry.
Our next question comes from Wayne Hood from BMO Capital.
Yes, good morning, I had a couple of questions starting I guess with HBC, this is a question they have implied to all three of you there I guess. You had more time to assess the leadership team there and now get on the ground and I am just wondering as you have gone through that, kind of the easy way that you can identify and that's coming from the merchandising teams in terms of processes they might be able to change and I guess also kind of related to that is a planned allocation function which may fit into what Paul's doing. Finally, you look at the real estate team there. Are they going to be able to absorb 20 locations because that seems like a pretty significant step-up from where they have been, especially over such a short period of time? And I guess related to that I got a little ramble here is that what level of comp store sales growth will they have to see there to really accelerate their EBITDA margin from where they stand today?
So I guess I will start so when we bought GALERIA comp off in Europe, it came with a very fulsome high quality team in place and we have basically kept that entire team since we acquired them in place and we are happy with the progress that they are moving. What we have been able to do is bring in a large number of additional team members in order to help move them in the direction and support the work and pace that we want to move of the business and so I think that that's where it's worked really well. As far as The Netherlands opportunity, the real estate, making it to the 20 or so real estate transactions was basically totally supported by our U.S. team and is almost done so.
And we did bring in some third party people that we have worked with in the past and that process is just about coming to an end. As far as taking over the additional work of managing the Netherlands business, we brought in a number of people locally from the Netherlands and our Chief Merchant of course is from the Netherlands so we think that we are in a very strong shape. Remember this is a €3 billion business with over a 120 stores. To be adding additional 20 stores is relevant important to say but is in keeping with the type of growth that should be manageable within that organization.
And Wayne this is Jerry, I would also like to say we are finding immediate opportunities in the business as well as longer term opportunities so right away as we took a look at it, there were some things from our U.S. businesses frankly as just our retail experience they were able to apply to the business there and while the seven-tenths of 1% positive same store sales may not seem like a large number, it's a significant capture of market share based on the data that we see.
Keep in mind, we didn't mention it in our press release or discussion because we think we did pretty well there frankly in the first quarter. But there was significant downward pressure that was caused by the terrorism there and we own the largest store in Belgium and the comp store sales in Belgium were significantly negative and the overall comp store sales in Germany alone would have been up quite a more than the seven tenths of 1% you see there but Belgium stores particularly the ones in Brussels were simply down, significant double digits because of what happened.
And so the team there, I think is responding very well. We have ideas that come out of the U.S. and bring them there. I find that they execute them very rapidly and it's already, most immediately you can affect the marketing and promotion and business and we have done that and it takes a little longer to affect the product assortments in the business keep in mind we took possession of the business until half day of September I believe last year so it's only we are entering now the first chance we have had in the third quarter of the business getting towards the year. So, the first chance we would have to affect the assortment, you start to see new product introductions later in the second and the third quarter in that business and time for the holidays which is the first attempt, chance we have had to affect the actual assortment in the businesses and we are bringing new brands at that time.
At that time, in terms of remodeling of the stores which is a big part of our strategy there to ring the playbook that we use the playbook for Canada in Europe and that takes a little longer to plan. For what we are starting now with the renovation of the Dusseldorf store, it's the pilot store for the renovation program. That is under way and is a significant remodel of that store. We expect to see the kind of results that we have seen in Canada and the results seen in the United States with our remodels as we really got a system on how to do this, so that's starting now. So we are starting to feed in the benefit. I mentioned earlier the internet, the teams are working much more closely together now and on the mobile side, the Gilt teams and the Saks teams are helping to move more rapidly there because you know how important mobile is for the internet going forward so we are starting to get those synergies in place.
Meanwhile, we have a significant team of people in North America working with them. We never want to be arrogant. We bought the company and we said oh, you can't just bring in everything North America into Germany or else you would have the problems Walmart had and others in Germany and we have not done that. But we have brought a lot of expertise to bear across different functions of the business and they are starting to feed into the business and work well in both directions on that kind of sharing. And Richard & I as you are in Europe today and working with the team and we continue to make progress into that business.
Yes, my two follow-up questions would be on Saks back to the U.S., can you speak to any further refinement that you guys are making in the brand which will lead to new brand additions, exiting brands that are not tailing into the growth curve. Do you really kind of differentiate yourself in that market and then Jerry you mentioned that you feel better than you had about the business probably due to terrorism about the business. Are we to take that to believe that maybe early part of the second quarter is a little bit better and how are you not being dragged down into the clearance we see Macy's and others going through right now?
Yes, Saks of course is very different from Macy's in terms of the mix of the business but the, what we are focused on, what we are seeing is the fashion is selling very well. Now when there is something that's really different and unique it's selling and I am not so much focused on immediate sales today in terms of the comp sales doing better or worse or whatever it is and we couldn't do that anyways in terms of what we are seeing in the second quarter but when I walk the halls and speak to the merchants they are telling me that the Fall goods, the new goods are selling very well so they are getting excited about some things and there's still some pressures in the business because of what's going in luxury overall.
But the net of it all is every once in a while they are saying some positive things now whereas if we go back a few months ago that simply wasn't true. It doesn't mean that there is a seat change, I just want to underscore that. There is still a significant pressure on luxury in general in United States and on that business but every once in a while you hear something good now which is a big change from where it was before so we will see how that goes. But I am saying I just feel better about it based on what we are seeing. We are very heavily focused on the hot fashion brands that are selling, that are working and making sure that we shift our inventory into those brands. It's not so much getting in and out of individual brands because it's rare in the Saks that having luxury feel that a single new brand makes a big difference in the business as it is shifting weight towards the businesses that are incoming as opposed to those that have been stressed or on the way down.
We're really excited by what we saw in terms of our openings in both Toronto and Houston. We were able to impact that matrix in that way and choose what we wanted to reflect a sort of go-forward look at the business and by the sales that we've seen as a consequence of that, we're bringing that same kind of matrix in Brookfield in downtown New York as we open up there in a few months, and we're feeling much better about that as well. I don't want to exaggerate sort of this sense of greatness about or good feeling about Saks, it's still a tough business, the toughest part of our world, I would say. But we understand the rationale why, we're starting to respond, and there's some good news coming out of there occasionally now from the merchandise calls that people are making.
And again, you asked a question about Macy's, and I do think that that promotional posture did affect our first quarter in regards to our department store group, in terms of Lord & Taylor and even Hudson Bay. And again, people at the end of the year were very heavy in inventory and had to get rid of it. Saks, it's somewhat the same but it's a whole different set of vendors and a whole different situation there. As you know, you can't even put stuff on sale whenever you want to in that business. You have to follow the schedule laid out by the vendors for when there are breaks and when you can do that sales activity.
Our next question comes from Patricia Baker with Scotiabank.
Thank you and good morning, everyone. Paul, you -- with the release of the first quarter, you did maintain the full year guidance. Can you just provide us with some backdrop of what achievements in the quarter or what in the P&L of Q1 contributed to you being able to maintain that guidance for the full year?
Thanks Patricia. So, as we outlined in our release, as we think about Q1, you have to keep in mind that the lower earnings this quarter are driven largely by the impact of the joint ventures and associated rent, which is spread evenly throughout the year and, that coupled with the seasonality of the retail business, results in a much more significant impact of the rent on the early part of the year versus the back half of the year. We do expect lots of that comparable sales and earnings growth will be driven by a number of initiatives, some of them are cost-saving initiatives, an ongoing focus on generating same-store sales growth, and also as Jerry's already mentioned, weather returning to a normal weather pattern. And our guidance anticipates a low single-digit comparable sales growth and earnings improvement as we continue to focus on SG&A, which is a very, very significant initiative within the organization.
Okay, I appreciate that and I fully understand that. So obviously though, and I'm not expecting you to tell me the numbers, but there would have been some kind of performance in Q1, some threshold, which would have led you to have to change the guidance. You know, notwithstanding that it is a seasonally weak quarter, whatever the threshold was that you had to achieve in Q1, you've achieved it. Is that fair to say?
Yes, I think that's fair. And it's based on our expectations at this time of the performance through the balance of the year.
Okay, fair enough. And I really appreciate the discussion earlier where you provided us with some sense of the trends that you saw in the quarter with respect to the gross margin of OFF 5TH Canada, U.S. Where would Europe lie in that continuum vis-à-vis the pressure that there is on gross margin if Canada has pressure on gross margin but not as bad as the U.S. In that continuum, where would we slot Europe?
Jerry, do you want to take that?
Sure. So we are being very aggressive in our European business and so there is some pressure on gross margin there, but we've generally have been making the right decisions there that have resulted in EBITDA-positive changes. I mentioned earlier in response to Wayne Hood's question that we've taken a strong look at their marketing calendar and their promotions, and we've changed some things. And as we've done those, some of those have driven EBITDA but have lowered the rate a little bit. So I think what we've seen there is mostly a consequence of decisions that we've made that we believe in and that are EBITDA-correct decisions.
That's very useful, Jerry. Sticking with Europe, so coming out of the quarter, what are you seeing with respect to the mood there and traffic, what kind of improvements have there been made post the terrorism impact?
I think we're starting to see a pattern. It's just almost horrible that we have to talk about these things, the way the world is these days. But I think we're starting to see a pattern fall in and I hope there are no more terrorist incidents, but if there are, what we're starting to see is that the recovery period is shortening and it kind of reminds me what -- I guess I've been in retail long enough to remember what was happening in England when there were a lot of terrorism incidents there, and what you saw is it became more like, I think it's horrible to say this, more like business as usual, where the cycle of recovery is shorter, it's almost sort of expected that these events might occur.
So generally, I feel the mood is pretty good. The other thing that I just want to share with everyone is that safety is our first priority for our customers and associates, and we always made the decision to do what's right there, both in terms of closing a store if we had to or adding security, whatever we had to do, to make sure that we're well positioned for that. But it remains kind of a cloud over Europe, but it feels like authorities may be getting a better handle on this. And, as I said, it's horrible to have to even talk about this but it feels like the recovery time after one of these events is shortening with each subsequent one.
And Jerry and I've spent a lot of time walking the high streets in different markets in Europe and they're filled with people, and people are shopping, and as you can see from our trends, we're seeing business better in Europe than we're seeing in the United States. So that's kind of the backdrop that Jerry discussed.
Outside of Brussels itself, even the rest of Belgium is much better. Outside of Brussels itself, there'd be no sort of -- you wouldn't be aware there was anything.
Okay, that's very good. I thought it was interesting, Jerry, when you talked about the changes that you've made in OFF 5TH, and noted that you made the changes because the previous pricing structure, the consumer was very confused about what the prices really were. And so if you sort of come over to the side where we are looking into Hudson's Bay Company and trying to determine what really happened operationally in the first quarter. It's somewhat analogous. We have year-over-year comparisons which are completely invalid because the company's completely different than it was a year ago. We no longer have the segmented reporting, and that is what it is. And then of course notwithstanding that it's a seasonally weak quarter. Could you just step back and summarize, by market, what you think were the top three operational wins so we can get a sense of the operational progress by market?
Wow, that's quite a question. But I'll do my best to answer it. But thank you Patricia, and let's take a look at it. Clearly in Canada, I'd have to put first the entry of Saks OFF 5TH and Saks as number one, and that's gone on very well. And associated with that, I'd say we're very pleased at Hudson Bay, that we held on to our business as we did that, so a very solid Hudson Bay business even as we did that, down to the individual stores in malls, where we added Saks 5TH Avenue to the business and also the markets where we added Saks OFF 5TH. Certainly we were interested in the interplay and frankly we had forecasted some impact on our business that did not occur. If anything they were synergistic benefits.
The third thing I would mention in Canada was the rapid rate of growth that we're seeing in hudsonbay.com and I often say that if before this thing about the company if -- Hudson Bay had been at the top of its game at the time that Hudson Bay should have been Amazon of Canada, when you understand the importance of Hudson to the Canadian heritage and the Canadian marketplace, and as we've improved the internet experience there and continued to do so, we're seeing very rapid growth rate at hudsonbay.com. And it's no coincidence that the first one of our K shows which is our new robotic technology, we find a way we show/organize analysts tour of that the right time. But it's a no coincidence to the first one we're putting into this Ontario because we needed to accommodate the growth of hudsonbay.com and we see truly an unlimited flight path for hudsonbay.com as we look to the future, and so that's a big win for us in Canada.
So Canada overall, is a really good new store for Hudson Bay. So now if we turn to our business in Europe I would say that the most important thing overall is the way that we are transforming the business both in terms of the new people that we are hiring and bringing in, the transfers from the U.S. that are joining the business as well as structural changes in the business you saw mentioned in the press release in our earnings call about the restructuring at the headquarters with the voluntary retirement there. And so we feel like we are getting a lot of traction in regards to the foundational elements for the future of the business. Also even though it is not apparent in the results yet we are preparing or the launch of Saks OFF 5TH in Europe which will be both in Germany and now in the Netherlands and we believe that's a significant market opportunity in Europe for the business and for both Germany and the Netherlands.
And then thirdly, again not yet reflected in the numbers but we see where we are going. We are very far along in terms of planning our capital investments in Europe for transforming the physical plans of the stores to bring our dream concepts to bear and our playbook for how to change stores which are fine enough and not as contemporary and not as strong in Handbags, Jewelry and Beauty as we believe a modern department store should be. So we have specific plans for how to do that and we are ready to go forward with them. If we look at the United States and what we see going on there, there are some improvements in each banner so we talked to Ray a lot about Saks OFF 5TH and Gilt and what's going on there and again I am very excited about that.
Sometimes people try to make these kinds of pricing changes in the past you have seen dramatic swings in results that now what we have seen in fact, we have seen an increase in profitability in Saks OFF 5TH from these changes so it is playing exactly as we wanted and we are very excited about the future that we see there at Saks, despite the overall pressure on luxury when we do something new we give a reward for it. I remember the store in Houston, I mean the numbers there were just superb for the store opening there and we are thrilled with that and so we think that we are developing a playbook there that we can roll out to other stores as we go forward. And then Lord & Taylor highlight something that we haven't talk about in the long time is that we haven't talked too much about Lord & Taylor today but at Lord & Taylor we have a strategy there called be the difference.
We focus on making sure that we more than double the amount of merchandise sold at Lord & Taylor that's exclusive to us. That could be private label merchandise or exclusive merchandise from our vendors. We made significant progress there and I really like the assortment at Lord & Taylor right now and I encourage any of you who get an opportunity to visit a Lord & Taylor store to do so and see all the new brands that we brought in there, [indiscernible] is really cool. Our own brand is fantastic. We have a deal with Excel where we're bringing in a number of new brands into the store and we're excited about those as well. And so we're well on our way towards separating the assortment at Lord & Taylor from what you see and is a more mass market apartment stores in the market which is I believe critical for future prosperity for that banner so we are doing a lot and haven't really gotten to the internet yet where the list of improvements through our websites our mobile experience, new launches we have over the next few quarters is truly phenomenal. Our teams have been working very hard on this and again we expect to see lot of benefit from that as we get to the back of it.
Okay, thank you Jerry.
Our next question comes from Brian Morrison with TD Securities.
Yes, hi, thank you. Question for Paul please and I just want to go back to Mark's question on rent as a percentage of EBITDA. I think it is pretty fair to say your real estate portfolio doesn't appear to be reflected in your share price so excluding the distribution return from the JV's rent expense including third party is probably around 55% of EBITDA and that obviously doesn't take New York City flagship under consideration. So how do you look at the rent coverage relative to EBITDA as you look to unlock the real estate value or what are other considerations we should be look at as you look to surface this value?
Alright, so during the quarter we paid about $128 million to third-parties and net cash flow into a JV of about $61 million. The way we look at it, we look at it as a percent of sales and in retail you wanted to be really ideally under 10%. During the quarter we are about 6% so we are well under that and as I mentioned in the response to another question, if you look at the first quarter relative to the amount of sales the rent is going to be disproportionately high. So that's how we think about it.
Okay. So then just to follow-up what do you feel you have to do surface this value?
Well, as our rent goes up our book value goes up so our book value has risen 17% year-over-year so we have created a tremendous amount of value with our real estate structure. Our real estate structure has also allowed us to come in and buy GALERIA and Kaufhof this past year without increasing our share count and without increasing our debt and putting us into the position to increase our EBITDA substantially. So as we discussed numerous times as we continue to grow our real estate portfolio, diversify the credit we are going to be progressive and move forward on monetizing the real estate in most likely a weak-type structure.
Okay, thank you, Rich. And I appreciate the methods in which you purchased Saks and Kaufhof as well. One, just a quick follow-up if I can, with the success of your Queen Street location are there any other stores within a store opportunity for Saks? I noticed Calgary is separate and Sirocco [ph] assumed downtown was too small. But are there any base store locations such as Vancouver, Montreal potentially which could house such a scenario?
Absolutely, and not only in Canada but perhaps in countries like Germany, so in Montreal for example when we acquire the Hudson Bay company, Montreal was the most profitable store and had a total sales of slightly less than the Queen Street store. The sales of the Queen Street store for this year, the year ending this year are going to be almost triple of what the sales were when we first acquire the company. Meanwhile the Montreal store has had just modest increases in sales because we haven't done same kind of improvements. We are working on plans that could include a Saks store and could include additional renovation similar to Queen Street which we believe now that we have tested it and seen the results could have substantial increases in a store like Montreal. So we definitely, Jerry talks about being the innovators at the Hudson Bay company and we think that our Queen Street store is an innovative concept that will translate in other stores in Canada and will translate in other stores in Europe.
And by the way I would add that the next store that has opened is actually Saks OFF 5TH store inside of the Hudson Bay store in the Rideau center in Ottawa. And as opposed to with Saks OFF Avenue store than a Hudson Bay store and Saks OFF 5TH store and Hudson Bay store, we are very excited about that and we again will have a completely renovated Hudson Bay store plus Saks OFF 5TH store in the same real estate. So we are trying many different things that will be able to be translated around the world and we are excited about the successes we have and we think that we have a lot of opportunities ahead of us.
That's helpful. Thank you, Richard.
And I am not showing any further questions at this time and would now like to turn the call back over to our host.
Thank you very much. We appreciate your interest in Hudson Bay. Have a great day.
Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.
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