Ascena Retail Group, Inc. (NASDAQ:ASNA) Q2 2019 Earnings Conference Call March 14, 2019 4:30 PM ET
Jennifer Davis – ICR
David Jaffe – Chief Executive Officer
Gary Muto – President and Chief Executive Officer-Ascena Brands
Brian Lynch – President and Chief Operating Officer
Robb Giammatteo – Chief Financial Officer
Conference Call Participants
Susan Anderson – B. Riley FBR
Steve Marotta – CL King & Associates
Good day, ladies and gentlemen, and welcome to the Ascena Retail Group Second Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference may be recorded.
I'd now like to introduce your host for today's conference Ms. Jennifer Davis from ICR. Ma'am, please go ahead.
Thank you. Good afternoon, and welcome to Ascena's second quarter fiscal 2019 earnings call and webcast.
Before we begin, I'd like to remind you that certain statements and information made available on today's call and webcast may be deemed to constitute forward-looking statements. These forward-looking statements reflect the company's current expectations as of March 14, 2019 and are subject to a number of known and unknown risks and uncertainties that could cause actual results to differ materially.
The company undertakes no obligation to revise or update any forward-looking statements. Additionally, today's call and webcast may refer to non-GAAP financial measures. A reconciliation of GAAP measures to non-GAAP measures discussed today is included in our earnings release, a copy of which was filed with the U.S. Securities and Exchange Commission and the current report on Form 8-K earlier today.
Please refer to the For Investors section of ascenaretail.com for a replay of today's conference call. Note that the company has posted a supplemental slide package to augment information provided on today's call on its IR website and as an attachment to its 8-K released earlier today.
Hosting today's call are David Jaffe, Ascena's Chief Executive Officer; Gary Muto, President and CEO of Ascena Brands; Brian Lynch, President and Chief Operating Officer; and Robb Giammatteo, Ascena's Chief Financial Officer.
Thank you. And I would now like to turn the call over to David.
Thank you, Jen. Good afternoon, everyone. We delivered our third consecutive quarter of enterprise-level comparable sales growth, with second quarter comps up 2%. While we were pleased with continued traction at the enterprise level, performance was again mixed across our portfolio. Our Premium segment continued its momentum, with double-digit comp sales supported by key growth initiatives. Our Value segment, while still operating at an unacceptable level of profitability, delivered operating income improvement versus the year-ago period for the first time since the fourth quarter of fiscal 2015. Unfortunately, we took a step back at our Plus and Kids segments this past quarter, and we must deliver more consistent execution to get enterprise financials back to levels that we consider appropriate.
We experienced a loss of $0.26 per share, which was in line with revised guidance we issued at the ICR Conference in January. We remain on track with all cost takeout and capability building components of our Change for Growth transformation program. We expect to realize $300 million in run rate savings by this coming July and continue to aggressively roll out capability enhancements, marketing and merchandise planning functions to drive top line and margin rate improvement.
The third and most critical component of our transformation program is growth from our core. We have made progress here over the past three quarters, but February performance was very challenging and as a result, we are well off our planned trajectory for top line growth. While we believe the challenging selling environment is a result of macro headwinds also impacting others in our sector, our third quarter outlet – outlook represents an unacceptable profit shortfall to the expectations we shared at the beginning of our fiscal year. As a result, we are working to accelerate plans that were already in development to take much more fundamental action to address our cost structure.
As part of our overall transformation work, we continue our efforts to explore opportunities to sell third-party services on our platform. We have completed our internal readiness review and are fully prepared to support external relationship that we are working to develop over the coming quarter. Securing third-party relationships will reduce the cost base for our brands, while allowing us to diversify our sources of revenue.
Additionally, we have identified plans for an incremental $150 million in savings beyond our existing Change for Growth program target, which will help drive operating margin rate expansion. Our objective is to maintain a cost control program that is able to offset inflationary pressure on an ongoing basis to allow flow through on top line growth and protect our profitability when macro challenges arrive. While we expect near-term conditions will improve as the customers shift their mindset this spring, we are acting with the appropriate sense of urgency to implement our new cost takeout activity and accelerate realization of savings near term.
We are committed to getting Ascena's financial performance back on track and continue to explore opportunities within our portfolio that can allow us to focus capital and management attention on those brands that we believe can deliver sustained growth and profitability by maintaining a differentiated position in the marketplace.
With that, I'll hand things over to Gary to discuss key developments across our brand portfolio. Gary?
Thanks, David. The second quarter represented another strong quarter at our Premium segment. LOFT delivered double-digit comp sales and merchandise market growth with comp growth in both its bricks and mortar and direct channels. Growth was driven by average dollar sale with strong product acceptance resulting in increasing both average selling price and units per transaction. Transactions were up low single digits for the quarter driven by the direct channel and specifically the new LOFT outlet side, which is approaching high teen penetration less than one year after launch.
At LOFT, we benefited from our winter strategy and we saw strength across more categories, most notably in sweaters, dresses and denim. We continue to learn and refine LOFT's newly launched plus assortment based on initial strong pilot this past season. We remain optimistic that the plus offering represents a meaningful growth opportunity at LOFT going forward. Ann Taylor also delivered double-digit comp sales and margin growth for the quarter with comp growth driven by direct channel, strong assortment performance resulted in increase in both average selling price and units per transaction. Transaction growth is driven by the direct channel and specifically the new Ann Taylor factory site, which has achieved mid-teen penetration in less than one year after launch. While product acceptance has been broad based, we are specifically pleased with our performance in our tops, dresses and tee category.
Moving on to Justice and Lane Bryant, we were extremely disappointed with performance at both brands this past quarter. At Justice, we believe the issues are short term in nature, but the impact was significant this past quarter. Our Kohl assortment continue to resonate with the second quarter with apparel comp sales up 4, and while our specialty assortment delivered flat comps for the quarter, it experienced significantly high clearance selling, which hurt overall margin. We made some overly aggressive chase decisions in September when the brand was delivering double-digit comp sales and traffic growth, and as a result, we were overbought in speciality inventory and the liquidation is highly seasonal, assortment had a greater impact than expected – impact than expected on margin.
We took action post holiday to deal with the overbuy and exited the second quarter in good shape from an inventory carryover standpoint. Looking ahead to spring, we are pleased with the initial reads we are seeing from our new fashion assortment in some warmer weather region. At Lane Bryant, the issues are a bit deeper, as I mentioned last quarter. We have been addressing Lane Bryant's market positioning since this past summer. We are rolling out new brand marketing that highlights the core attributes we need to build upon and become famous for with our existing and potential customer base.
Lane Bryant must enhance its emotional connection with its core customer and get credit for its functional benefit instead. Our new brand positioning and marketing is targeted to address these priorities moving forward. Specific to the assortment performance, we had a significant fashion miss in our Kohl assortment starting with our September tops delivery. And performance continues to erode as we move through our second quarter.
Candidly, our team missed the appropriated edit point for our customer. We took fashion a step too far and overdesigned many of our tops. We cannot have these misses go forward and have instituted new product hardware. While tops underperformed, we continue to build on strength in dresses and denim, which comp positive in the second quarter. We expect the top assortment performance will improve as we move deeper into spring. Aside from the apparel challenges at Lane Bryant, performance at Cacique was also down for last year, reflecting the current dynamics in the intimate sector.
We [Audio Dip] low performance in more basic part of our bra assortment, which was the largest contributing factor to our negative comps. We are effectively working to adjust and shift our inventory towards more differentiated fashion, which has seen stronger performance. In parallel, we have expanded our bra offering online and now have an inclusive range covering band sizes 32 to 50 and cup sizes A to K. We believe Cacique represents a meaningful long-term growth opportunity and are investing incremental market dollars to expand awareness and drive customer growth on a stand-alone basis.
And finally, at our Value segment. While the new dressbarn leadership team has delivered improved year-on-year performance, the brand is operating at unacceptable level of profitability due to the significant new leverage from fiscal 2018. We are exploring all options to address the overall level of brand profitability, including various customer contact and promotional strategies, along with additional cost takedown.
Maurices delivered a modest positive comp for the quarter on the back of very strong e-commerce performance, which was up 24%. Coming out of the summer season, we made adjustments to our assortment strategy to narrow its waist count and increase inventory debt in key [Audio Dip] and saw improvements in both average selling price and unit velocity. These positive developments were mostly offset by continued store traffic headwinds. We continue to test new promotional strategies, utilize our loyalty program and leverage localized online marketing to mitigate through a traffic decline.
As David referenced a moment ago, quarter-to-date performance has been challenging across our portfolio. We are taking what we believe is a prudent approach by not aggressively promoting in low traffic environment, which we've been experiencing. We are adjusting our forward promotional strategies to maximize our opportunity in high sales period [Technical Difficulty] and anticipate we will see a balance in overall traffic as the customer mindset shift to spring.
We are disappointed with our performance out of the gate in February, but we are focused on maintaining the momentum we have at LOFT and Ann Taylor, getting Justice back on track and [Technical Difficulty] at Lane Bryant.
With that, I'll hand it off to Brian for a brief update on our transformation work.
Thanks, Gary, and good afternoon, everyone. We are nearing the end of the Change for Growth transformation program and are focused on delivering the final components of our road map. Namely, our localized planning to build on customer experience management ecosystem, markdown optimization and size and pack optimization are fully implemented at all brands. Localized planning is going well at our Premium and Kids segments and we are rolling out to the Plus segment next month.
We remain on course with development of our customer experience management ecosystem as we completed foundational customer data and analytics work this spring. The new enterprise marketing tool set, including workflow as well as asset and campaign management capabilities will be implemented in all brands by the end of the calendar year, enabling wide messaging at scale and more effective use of our marketing dollars. We've seen our new loyalty program at Justice drive incremental sales and we are scheduled to launch programs in our Plus and Premium segments in April and May, respectively.
We believe delivery of the remaining capabilities from our transformation program road map will help our brands gain share in an increasing fragmented competitive space. One industry macro issue that had been moving – has been getting inventory through our ports of Long Beach, New York and New Jersey as many companies rush to get merchandise from China into the U.S. before tariff increases went into effect combined with timing of Chinese New Year. As a result, we have had to expedite transportation from port to our distribution and fulfillment centers. This pressure has continued into the early part of the third quarter, but we are seeing conditions begin to improve.
During this period, we have incurred additional expense to ensure delivery of goods in support of floor set timing at our brands. We're continuing to explore strategies to more proactively mitigate these challenges using a dynamic delivery metrics going forward, including options such as expedited vessels. We are on track to realize our $300 million cost takeout figure and are developing further structural cost initiatives for fiscal 2020 and beyond to improve profitability.
We have line of sight to an additional $150 million in targeted areas, including expansion of our fleet optimization program, demand management for non- merchandise spend and operating model efficiencies across the organization. Our goal is to improve profitability with these meaningful cost takeouts. As David commented earlier, we are acting with the appropriate – urgency to implement.
And with that, here is Robb.
Thanks, Brian, and good afternoon, everyone. Please note that the comments on this call will reference non-GAAP results, which exclude restructuring expenses in the extra week recorded in the year-ago period at our segment that affect year-on-year comparability. In addition, there were two timing-related items in our results that affect year-on-year comparability, but are included in our non-GAAP results. First, the 53rd week in our prior fiscal year, which moved a low-margin clearance to our fiscal second quarter this year. And second, adoption of the new revenue recognition standard, which changed the timing of private label credit card revenues across this fiscal year.
Consistent with past practice, we have posted a supplemental earnings package to our IR website and attached it to our 8-K to provide additional context on performance for the quarter. I will reference this document in my prepared remarks and may reference it as well during Q&A.
Turning to results, our second quarter loss of $0.26 per share resulted from merchandise margin rate erosion at our Plus and Kids segments [Technical Difficulty] 53rd week timing shift, partially offset by flow-through of positive comp sales growth. Slide 10 of our supplemental slide package presents operating income walk for year-ago period for reference.
Enterprise comps were up 2% driven by average dollar sale. Total transactions were essentially flat to last year with 17% transaction growth in the direct channel offset by a 4% drop in store count. Second quarter direct penetration was approximately 35% of net sales, reflecting an approximate 4 percentage point increase from fiscal 2018 driven in part by the new digital channels for Ann Taylor factory and LOFT outlet.
Total revenue was essentially flat to the year-ago period with comparable sales growth and benefit related to the new revenue recognition standard offset by a lower store count resulting from our fleet optimization work and the unfavorable impact of the 53rd week timing shift.
Gross margin rate of 52.2% was down 190 basis points last year, caused primarily by Justice comps, where an overly aggressive chase strategy in specialty goods required significantly higher markdowns to right-size inventory levels. The remainder of the rate decline was caused by product acceptance challenges at Lane Bryant, along with increased freight expense resulting from higher direct channel penetration across all brands. These factors were partially offset by improvement at dressbarn, which was up 270 basis points from last year.
Operating expense of $837 million was down $5 million or 0.6% for the quarter, reflecting transformation-related savings from store closures, mostly offset by inflationary pressure, channel shift and investment in growth initiatives. Specific to our transformation program, we've realized $26 million in savings in the second quarter driven by fleet optimization [Technical Difficulty] savings and IT efficiencies.
Touching briefly on our fleet optimization program, we ended the second quarter with 4,486 stores, reflecting 110 net closures in the quarter. Turning to our balance sheet, we ended the second quarter with $215 million in cash and cash equivalents and total debt of $1.372 billion, representing the balance of our term loan.
Our next scheduled amortization payment is not due until November 2020, and our asset-based revolver was undrawn at quarter-end. Between revolver availability and cash, we had $595 million in liquidity at quarter-end. Regarding our capital structure, net debt is 2.9 times trailing 12-month EBITDA, and trailing 12-month EBITDA is 4.2 times our annual interest obligation.
From a capital allocation perspective, we continue to believe debt reduction is the best path to generate shareholder value at this time and are exploring options to maximize the impact related to potential use of current balance sheet cash and remaining fiscal 2019 free cash flow on our existing capital structure.
At the total company level, we exited the second quarter with inventory of $693 million, which was up 15% from the year-ago period. Approximately, half the increase was caused by floor set timing, receipt flow related to the 53rd week shift and the impact of new revenue recognition guidelines. Excluding these items, inventory levels were up approximately 7% inclusive higher all season stock levels supporting key denim and bra launches. Please reference Slide 5 of our supplemental slide package for additional inventory details.
Capital expenditures for the second quarter were $34 million.
Turning to our [Technical Difficulty] performance to date has been challenging, and we are currently operating with reduced forward visibility on sales trends due largely to what we believe are macro factors impacting the general retail environment. As with past practice, we typically guide comps based on our trailing 13-week trend.
However, given the slow start to the quarter, we are basing guidance of quarter-to-date actuals and the trailing 13-week trend for the remainder of the quarter. This framework does not contemplate any favorable trend change in April and we believe it represents an appropriately conservative stance based on current conditions.
Our outlook translates to an expected third quarter loss of $0.35 to $0.45 per share supported by the following assumption. Net sales of $1.43 billion to $1.46 billion with comps sales down 4% to down 2%. The decline in net sales is expected to be generally in line with comp sales decline with the unfavorable impact of ongoing store closures mostly offset by the beneficial impact of the 53rd week shift. Detail related to the impact of the 53rd week by quarter throughout fiscal 2019 is highlighted on slide of our supplemental earnings package.
Gross margin rate of 57% to 58% with the midpoint down approximately 120 basis points from the year-ago period. The planned rate reflects merchandise margin rate erosion resulting in the February selling across our portfolio and expectations for continued headwinds from the channel shift towards the ramp. These factors are expected to be offset in part by normalization of rate at our Value segment driven by planned improvement at dressbarn, which was down over 800 basis points versus historical levels in the year-ago period.
[Technical Difficulty] expense growth of approximately 4% reflecting inflationary pressure, initiative spending and channel shift partially offset by store closures and transformation-related savings. And the third quarter comparative will be negatively impacted by the reversal of incentive compensation accruals in the year-ago period, which depress the prior year base.
For full year fiscal 2019, we continue to expect operating expense will be flat at 1%. Key assumptions related to our third quarter guide represented on Slide 9 of our supplemental slide package, third quarter earnings will be favorably impacted by the timing shifts related to the 53rd week in our prior fiscal year and the impact of the new revenue recognition standard together resulting in an approximate benefit of $18 million in operating income versus the year-ago period. This benefit is more than offset by the combined impact of our negative comp outlook, lower gross margin, increased operating expense.
Due to reduced visibility of current trend, we are not issuing full year guidance at this time. For reference, our current guide through the third quarter would translate to a year-to-date loss of approximately $0.60 compared to a $0.10 loss that was reflected in our original annual guidance for the first through third quarter period, with most of that shortfall coming in third quarter. The decline versus our original guidance for the first through third quarters is primarily related to lower than expected performance at our Justice and Lane Bryant brands.
In conclusion, while we believe the recent slowdown in trend is largely macro related, we are aggressively managing the items within our control. Our ongoing cost takeout activity has allowed us to continue to invest in key [Technical Difficulty] across our portfolio, while offsetting inflationary pressures. And we are accelerating activity in this effort to recover from what we believe is a near-term pocket. Our transformation efforts have created a more capable enterprise, and we now must deliver sustained comp growth across our brand portfolio to leverage our linear cost structure.
That concludes our prepared remarks. And we'll now open it up for questions.
[Operator Instructions] Our first question comes from the line of Susan Anderson with B. Riley FBR. Your line is now open.
Hi, good evening, thanks for taking my question. Nice to see the good performance at Ann Taylor and LOFT. I guess, I wanted to maybe touch on Justice. I think that the underperformance there was mainly related to over inventory on the accessories part, but I guess, maybe if you could touch on just the apparel and how that performed in the fourth quarter and going into first quarter? And then, if you're seeing any impact at all from the Gymboree liquidations, which maybe a little bit younger there, but just curious if you're seeing anything there?
Yes. It's Gary. I mentioned the apparel comp was plus 4 in the quarter. So we were fairly pleased with the progress that we're making there. As far as the impact of Gymboree, we really haven't seen anything. I would say current outlook, I think, it has been very uneven. There's just been a whole just drop in store traffic we've experienced as far as our entire portfolio. So we remain cautious for the outlook of the season. We believe that hopefully will improve as spring break starts to happen and we get closer to Easter.
Got it. And are you expecting the inventory mix between apparel and accessories to be more balanced in first quarter? Is it going to take longer than that to get the proper balance there?
We took all our – or we corrected all our inventory issues in the quarter.
Got it. Okay. That's helpful. And then, I guess, yes, so just, I'm not sure, if I heard you right, but did you say the third quarter to-date trends, really the weaker trends there are mainly coming from Justice and Lane Bryant? Or is it – did you see kind of a drop-off across all the formats?
We've seen a drop-off across the entire portfolio.
Got it. Okay.
We still see the – Premium brands are still outperforming the legacy, but there's step-down across all the portfolio traffic bases.
Got it. Okay. And then, I guess, just from what you could gather, I think a lot of retailers have seen a slow start to the quarter, but do you think it's weather related, macro like us needing tax refunds? Or is it – do you think there is a bigger broader theme going on there with the slowdown in consumer spending?
Susan, I think it's all of those things and probably more. The late Easter, I think, does have an impact as well. And until we get to warmer weather and Easter, we're not really going to be able to tell if there is an across-the-board slowdown in consumer apparel spending. So right now, we're just going to wait and see.
Got it. Okay. And then one last one, if I get through in there, on Lane Bryant. I guess, just curious on your thoughts. You guys are obviously rolling out plus size to your other formats including Ann Taylor, and we're seeing a lot of your competitors also roll out plus size. So I guess, how do you compete with the Lane Bryant's format in just as much more highly competitive environment now going forward?
Look, this is Gary. What we've seen with LOFT, the rollout of LOFT is that LOFT – while we've seen success in LOFT, we've really seen it around fashion print pattern and that's absolutely – reaction to the product is very much how the LOFT customer reacts to the product. I think Lane Bryant's customer is Lane Bryant's customer. Clearly, there's a lot more competition out there, but we've seen success in bottoms, specifically denim and in pants and in dresses, we have a top assortment issue that, I believe, a good portion of that was self-inflicted by us not really being clearly understanding what our customer wanted from us. We're taking quick action to remediate that, but we feel very confident that we will get that business back on track.
Got it. Okay. Great, thanks so much. Good luck for next quarter.
[Operator Instructions] We have a question from line of Steve Marotta with CL King & Associates. Your line is now open.
Good morning, everybody. Good afternoon, excuse me. Rob, I've one quick question for you. Want to put a finer point on the comparable store sales guidance for the third quarter of down 4%, down 2%. You're saying that, that is based on quarter-to-date actual as well as the trailing 12-week trend and doesn't account for any acceleration over the next six weeks, is that accurate?
So that's correct. The 13-week trend for the go-forward period and by default, that except – that is ignoring the recent challenges in February, right? So February has been down mid-single digits and our trailing 13-week trend was, I believe, around negative 1. So by default, we are assuming things get better, but we were not assuming a step change in April above that run rate.
Okay. Can you please remind us what – I know you don't give monthly comps, but maybe if you can directionally talk a little bit about March, April of last year, just specifically March and April of last year?
So March and April last year, Steve, represented about 75% of the quarter.
And what was the – again, I know you don't give monthly comps, but can you talk a little bit about what the comp was like during that window?
I recall March last year was very challenging from a weather standpoint, Steve. I don't have that material on me, but it's – yes, I can follow that with you on that afterwards.
No problem. We’ll take it offline. Thank you very much.
[Operator Instructions] I'm showing no further phone questions at this time. I'd like to turn the call back to Mr. Jaffe for closing remarks.
Thank you, everyone, for your interest, and we look forward to speaking with you next quarter. Have a good evening.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.