Hudson’s Bay Company (OTCPK:HBAYF) Q4 2018 Earnings Conference Call April 3, 2019 8:30 AM ET
Richard Baker - Executive Chairman
Helena Foulkes - Chief Executive Officer
Ed Record - Chief Financial Officer
Jennifer Bewley - Vice President, Investor Relations
Conference Call Participants
Oliver Chen - Cowen & Company
Patricia Baker - Scotiabank
Marcus - RBC Capital Markets
Meaghen Annett - TD Securities
Good day ladies and gentlemen and welcome to the Hudson’s Bay Company Q4 2018 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 be given at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, today’s conference call is being recorded.
I’d now like to turn the conference over to Jennifer Bewley, Vice President, Investor Relations. Please go ahead.
Good morning everyone and thank you for joining us today. With us today are Richard Baker, Governor and Executive Chairman; Helena Foulkes, CEO; and Ed Record, Chief Financial Officer.
This morning we issued a news release on our fourth quarter results. We also posted complete financial statements to our website and filed them on SEDAR. In a moment, I’ll pass the call over to Richard, Helena and Ed 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 activity, performance, goals or achievements, or any other future events or developments and other statements that are not historical facts constitutes forward-looking statements that are not historical facts constitutes 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 in the circumstances; however, there can be no assurances that such estimates and assumptions will prove to be correct.
Many factors could cause HBC’s results to differ, including levels of activity, performance goals or achievements, or future events or developments 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 May 4, 2018, the recent MD&A, as well as HBC’s other public filings available on SEDAR at sedar.com, and our own website, hbc.com. Listeners should not place any 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 to turn the call over to Richard.
Thank you Jennifer and good morning everyone. We made substantial progress this year on a number of crucial fronts. We sharpened our financial discipline, returned to positive operating cash flow from continuing operations, streamlined our operation, and built a strong management team. Since joining us a year ago, Helena and her leadership team have taken quick action to build a better business. Since we spoke last, the company closed several key real estate transactions. Through those deals, our balance sheet is much stronger. The foundation combined with our focus and financial discipline allows us to better capitalize our unique flagship real estate.
In February, we closed on the sale of the Lord & Taylor Fifth Avenue building for a total transaction value of $1.1 billion while maintaining $163 million of the transaction value as a preferred equity stake in the building. As current and future generations are changing the way they live and work, our partners will be investing to transform the landmark into a higher and better use.
In North America, we own or control the ground lease on 73 properties, including some with our joint venture partners. About 70% of our properties are in the top 10 most populist metropolitan areas in the U.S. and Canada. This illustrates the location and quality of our North American portfolio, which is complemented by our high quality assets in Germany.
In Europe, we sold a 50% interest in 18 wholly owned German properties to Signa for $375 million. That followed the $257 million received in November when HBC Europe and Signa combined retail operations and formed a real estate joint venture. The real estate we own continues to have significant underlying value and we will always consider the most productive ways to use these assets. I believe in the inherent value of HBC and our strategies to unlock the value for our shareholders.
Now I will turn the call over to Helena for more on our strategy.
Thank you Richard, and good morning everyone. Throughout the last year, we took decisive steps to position HBC for the future. After an intensive review of our businesses, systems and operations, we took bold, strategic actions while fixing the fundamentals across the organization. Today HBC is a stronger and more capable company than a year ago. In our continuing operations, we returned to positive operating cash flow, improved the bottom line across all businesses, increased adjusted EBITDA by 30%, and strengthened our balance sheet. Financial discipline is not a one-year event. We will continue to improve our cost structure while making strategic investments in technology, marketing, digital, and our stores.
We’ve streamlined the organization which has enabled us to focus on our North American operations. We have divested Gilt, entered into a partnership for our European retail operations and real estate assets, and are currently optimizing the Lord & Taylor and Saks Off Fifth footprints and closing Home Outfitters.
We also made significant headway in strengthening retail operations. We have deepened our understanding of our customers, appointed new leaders, and pushed key processes and decisions into our businesses. This has created a culture of accountability and a simplified operating structure. With these changes, we are well positioned to prioritize our two largest businesses, Saks Fifth Avenue and Hudson’s Bay, both of which present the greatest opportunities for long term growth.
During the fourth quarter, Saks Fifth Avenue achieved its seventh consecutive quarter of positive comparable sales, up 3.9%, delivering an industry-leading two-year stacked comp of 7%. These results were driven by strong performance at stores outside of New York City as our Fifth Avenue flagship grand renovation continued through the holiday season. Saks continues to build upon its long-term strategy to elevate the brand through a fashion forward offering and increased customer engagement with an emphasis on personalization, individuality, and ease. Styling, service and an omni-channel experience are core differentiators for Saks. Fourth quarter performance was helped by a notably strong sales through the Fifth Avenue Club, our personal shopping service available in all stores.
With the New York flagship’s ongoing renovation, we are reimagining and redefining the store concept and evolving the way customers experience luxury shopping. While the construction negatively affected fourth quarter results, we reached another milestone in early February with the opening of the new main floor, one of the largest luxury handbag assortments in the world. We also linked the first two floors of the store with a state-of-the-art Rem Koolhaas-designed escalator with color changing iridescent glass and multimedia screens, providing customers with a truly Instagram-able experience.
Since the opening, the store has seen a nice increase in traffic and sales on the main floor and in beauty on the second floor. Overall, the flagship is on plan as the renovation is continuing with construction in women’s shoes, one of the most popular, highly trafficked departments, and The Vault, our soon-to-be-open luxury jewelry presentation on the lower level.
L’Avenue at Saks also opened in early February. As the world renowned restaurant’s only location outside of Paris, this is another example of how Saks is disrupting luxury retail and providing customers with even more compelling reasons to visit the store.
At Hudson’s Bay, Q4 top line performance was not up to our expectations and we are capable of better results from what is a solid business. If you look at the entire year, key performance indicators such as number of transactions and units per transaction grew, gross margin improved, and like all of our businesses Hudson’s Bay improved its profitability. The top line momentum shift was primarily driven by customers purchasing lower priced merchandise which unfavorably impacted basket size. While market watchers have been concerned about the health of the consumer, our belief is that our own merchandise choices created the shortfall. We’ve been addressing this challenge in 2019 and our fall assortment will reflect changes in our buying strategy.
Through our net promoter score data, we have learned quite a bit about how to improve our service at Hudson’s Bay. Using NPS-derived insights, we implemented tests in certain stores. This includes a pilot program for open sale in men’s and women’s shoes, which sparked an increase in sales as compared to stores with a traditional model. This is one example of how we’re using data and new dashboards to make better, more disciplined decisions for the business.
While we’re in the process of searching for a new president of Hudson’s Bay, key members of the HBC team are leading the business under my oversight. As Canada’s preeminent multi-category retailer, we believe that with time Hudson’s Bay can improve performance and return to top line growth.
At Saks Off Fifth, we achieved another quarter of improved profitability and the rate of decline moderated in our comp stores. While Off Fifth is one of our smaller businesses, there is opportunity within the popular off-price market. As a result, we’ve adjusted our go-forward strategy including our buying, service model, and marketing so that we operate less like a small department store and more like our version of an off-price retailer, providing fashionable, on-trend items that give customers the thrill of the find. I’ve said that it would take us until 2019 to see better results from this division and we are optimistic that our progress will be more apparent this year.
For the year, the Lord & Taylor team dug deep to improve their profitability despite falling sales. What I appreciate about this team is they see investment constraint as a way to be creative That can-do spirit has translated into better service for our customers and pockets of growth online and in certain departments. We are prioritizing profits over growth at Lord & Taylor with an emphasis on continuous improvement.
Digital is a key strategic pillar across all of our businesses. In Q4, we saw comparable sales growth of 8.7% across our digital channels. We see an opportunity to increase our digital penetration and have a road map to do so. For example, we’re making improvements to the shopping experience through the introduction of personalized home pages and improved site speed and navigation. At Saks, we’ve begun implementing online recommendations based on previous purchases and style preferences. This is the gateway into offering deeper, intuitive personalization across the entire digital platform, a priority in 2019.
We’re also continuing to elevate the omni-channel experience by providing our frontline sales associates with the necessary digital tools to drive sales while supporting a frictionless shopping environment. One example is with Saks, where we are using geo-locating technology to connect in-store associated with customers shopping through our mobile app. More broadly, we’re taking our highest traffic channel online and fusing it with our best converting channel, our store associates. We’ve seen positive results from these new ways of connecting with our customers.
At Hudson’s Bay, we’re pleased to report that since migrating to a new platform late last year, we have seen positive customer feedback on thebay.com with an increase in NPS scores among online shoppers. The changes that have been made to date establish the foundation to better serve customers and there is still opportunity for further improvements.
2018 was a year of significant progress throughout the company. We identified areas with the most opportunity for immediate improvement and took swift action to do so. I’m proud of the leadership team and our associates for all of their hard work and embracing the critical change that needed to happen and their continued commitment to operating a better business.
In 2019, there will be more opportunities for change and I’m confident in our ability to capitalize on them. Our top priorities include: one, making focused investments to drive growth at Saks and Hudson’s Bay; two, enhancing the customer experience across all channels; three, reducing operating costs and complexity and continuing to fix the fundamentals; and four, capitalizing on the value of our real estate. All of these actions are crucial in ensuring we can operate from a position of strength as we work to improve performance and create long term value for our shareholders.
With that, I’d like now to turn the call over to Ed to provide additional details on the financials. Ed?
Thank you Helena, and good morning everyone. During the fourth quarter, we generated $460 million in cash flow from continuing operations, up $177 million or 63% year-over-year driven by a sharp improvement in our working capital. We started the year with a goal to bring down comparable store inventory by 5%. At year end, we met our goal with every business unit carrying less inventory than at the previous year end. Our merchants continue to refine their go-to-market strategies and HBC continues to roll out tools and processes to support data-driven decisions, decisions that serve our customers, further reduce inventory, and speed turnover as well as provide opportunities to improve our gross margins.
In the fourth quarter, gross margin was 36.7%, down 200 basis points year-over-year which was driven by inventory liquidation related to our store closings as well as a provision for Home Outfitters. In February, we announced that we’d be shutting down Home Outfitters, which has 37 locations throughout Canada. In 2018, Home Outfitters had revenues of $113 million and negatively impacted our adjusted EBITDA by $7 million. The closing sales have begun at Home Outfitters and we anticipate closing the business unit at the end of the second quarter.
2018 gross margin was 39.9%, up 110 basis points year-over-year when you exclude the one-time liquidation impacts. Each of our businesses contributed to the gross margin improvement. Our strategies drove higher mix of full price selling at better margins and higher margin rates on our clearance. We are making good progress at each of our business units on the interplay between inventory and gross margins and will continue to focus on optimizing our inventory levels in 2019.
Controlling spending allows us to make smarter investments in technology, digital and marketing while maintaining fiscal discipline. Adjusted SG&A totaled $922 million in Q4, down $56 million from a year ago. Even when we take into account one less week in this year’s Q4, adjusted SG&A declined year on year. For the full year, we were able to leverage adjusted SG&A by 9 basis points. While small, it is a reflection of our progress. The fundamental fixes will continue in 2019 with a goal of providing better customer service and driving innovation at a lower cost in the future.
In November 2018, we completed the merger of our European retail operations with those of Signa’s which combined Germany’s two major department store chains, Galeria Kaufhof and Karstadt, into a retail joint venture. We also created a real estate JV for our European properties. HBC owns 49.99% of the European retail JV and Signa owns 50.01%, while we both own 50% of the real estate JV. We report the retail joint venture’s results on a one-month lag and use the equity method of accounting.
In the fourth quarter, our share of the European department store group’s adjusted EBITDA was $88 million. When you exclude their impact, fourth quarter adjusted EBITDA was $187 million, down from $216 million a year ago primarily due to weaker top line performance. For the full year 2018, adjusted EBITDA grew 30% or $77 million year over year to $338 million. To frame up our progress on profitability, our $338 million of adjusted EBITDA nearly bested our 2017 results of $346 million, when we still owned 100% of Kaufhof and Gilt and had more retail locations than our comparable operations.
Capital investments net of landlord incentives were $126 million during the fourth quarter. For the full year, net capex totaled $194 million. Excluding the unbudgeted tenant inducement of $152 million from our Oakridge landlord, net capex totaled $346 million, well below total capital expenditures of $599 million in 2017 and within our guidance.
With regard to the balance sheet, since the end of fiscal 2017 we have taken substantial steps to fortify our financial position. We permanently reduced our term loan by $233 million, we eliminated the $510 million Lord & Taylor mortgage, and while we fell short of our goal of having no borrowings against our ABL at year end, on February 11 we paid down our ABL an additional $252 million from the Lord & Taylor transaction. Since the end of fiscal 2017, we’ve paid down approximately $1 billion in debt, including $762 million after the fourth quarter close.
Looking ahead, we are comfortable with our leverage ratio and we continue to improve our capital structure. We have ample liquidity and the flexibility to support our strategy. We are also committed to running all of our businesses efficiently and are exploring additional opportunities to reduce expenses as we focus on improving free cash flow and overall operating performance. In-flight programs at HBC include improving our merchandise planning, allocation and supply chain, further optimization of in-store scheduling to best meet customer demand, and advancing our digital operations and marketing mix. Based on our strategic plans, we expect our financial performance to improve in 2019.
In terms of cadence, we anticipate adjusted EBITDA will be lower in the first half of the year by comparison to the previous year. That is driven by a late start to spring selling in part driven by the later Easter holiday and the timing of the expected benefits of our strategic initiatives, which are expected to fully take effect in the fall season. In 2019, we will continue to moderate our capital spend and anticipate spending between $300 million and $325 million net of landlord incentives. We are making investments in stores, digital technology and digital fulfillment for Saks and Hudson’s Bay.
The reduction in capital expenditures as well as our working capital reductions will contribute to our goal of improving free cash flow in 2019. We made good progress in 2018 and our financial discipline is unwavering in 2019.
Before I close, I want to highlight a couple of changes related to our financial reporting for next year. HBC is switching to U.S. GAAP which will cause some adjustments to our historic results. We are taking this change as an opportunity to refresh the way we communicate our financial results to our shareholders. Our goal is provide additional information to help you understand and assess HBC, both as a whole and by our most valuable businesses. The proposed changes will include providing retail sales information by each business unit, eliminating adjusted SG&A, and clarifying our presentation of adjusted EBITDA to better reflect the contribution from our North American retail business, our real estate joint ventures, and our European retail joint venture.
We will be seeking your feedback over the next few weeks to help us improve our disclosures for shareholders. Once we’ve collected additional input, we will share our historic financial results in a new format for your ease and updating models no later than April 30.
That concludes my remarks. Operator, we will now open it up for questions.
Our first question comes from Oliver Chen of Cowen & Company. Your line is now open.
Hi, thank you. The Saks numbers have been really impressive. What are your thoughts about what’s happening in the marketplace because there are some cautionary factors with incoming tourism, stock market volatility, and I’m also curious about how you’re thinking about the good-better-best opportunity and making sure that your existing customers are engaged and satisfied, as well as bringing in new customers as you think about pricing and brand matrices, because you’ve made some really good strides into the fashion arena. Thank you.
Thanks Oliver. Yes, we’re very excited and pleased about what’s going on at Saks and, as you said, have a 3.9% comp in the quarter, which is a 7% two-year stack is great. People keep talking about the marketplace, but we are feeling pretty good about the year that we’ll continue to see this level of growth. If you think about our business, for example, 2018 in the fourth quarter we had significant construction going on in our largest store, obviously the Fifth Avenue store, and still produced those kinds of results, so I think the foundation is good.
I can’t speak to what happens in the marketplace, but I would highlight a couple of things that the team is doing really well. First is, to your point, the merchandising team has done an excellent job really going after more fashion forward product and getting to the price points that we think are really helping drive the business. We’re getting credit from customers, you can see it in our branding work, we are really standing out in the marketplace for what we’re doing from a fashion perspective. I think that’s a big part of what we’re seeing in terms of results.
The second thing I would say is the team is doing a phenomenal job as it relates to personalization, which is a key part of our strategy from a go-forward perspective. One element that we haven’t spoken much about, but the work we’re doing at the Saks Fifth Avenue Club, which is a personalized shopping experience that we have in every store has grown really well over the past year, and we continue to see opportunity there. We’re now taking some of those insights from the Fifth Avenue Club in particular and driving them to the next tier of customers. It’s the early stages of that work and too soon to report on it, but feeling again encouraged by what we see as opportunity.
The last thing I would say is digital. A year ago, stores were growing faster than the digital business, and I see now really nice momentum in digital at Saks. What I’m particularly excited about there is it’s the marriage of the online and the store that allows us, I think, to differentiate and be very meaningful to customers. We’re very pleased with Saks and we’re continuing to see that 2019 will be a good year for us.
Thank you. Ed, the comments around cash flow are encouraging. For next year, what are your thoughts about the working capital and how that will help the cash flow, and any guidelines around free cash flow in general? As you think about inventory management across the banners, which banners have the most opportunity to take inventory per square foot down? Thank you.
Sure. Morning Oliver. I think when you look at inventory, I think we did a nice job this year. We ended down, I think 5.1 on a comparable store basis with every banner down the last year. Frankly looking forward, we would expect to see low single-digit reductions again in inventory as we head into 2019 and throughout 2019. We think every banner has an opportunity. As you benchmark our [indiscernible] or turnover, whichever you prefer, all of them compared to their competition have opportunity, so we expect to see improvement in all of them.
As we look at free cash flow moving forward, we made some significant progress this year even on a North American operations standpoint. Last year it was about $330 million cash burn, this year it was $140 million-ish cash burn, so we more than cut it in half and we expect to be able to make improvement on that number next year.
Thank you. Just lastly, the U.S. GAAP sounds very helpful in terms of adding navigation and making it easier to analyze a lot of what you’re doing. Why was now the right time for that decision, and just context about the change would be interesting? Thank you.
Well, I know U.S. GAAP so I’m making the whole company change - no. We brought Rhone in as a partner and given our foreign private issuer status, we really felt it was important for us to convert to U.S. GAAP so that if and when they ever decide to sell, there won’t be any impediment to them doing so. That’s what really drove it.
IFRS is great. I do think--you know, the nice thing about U.S. GAAP is the way they’re taking on lease accounting, so our years will be comparable to the prior years. Our EBITDA and net income won’t change because of the lease accounting standard, so we feel that’s important as we move forward and should be really helpful to the analysts.
Okay, thank you. Best regards.
Thank you. Our next question comes from Patricia Baker of Scotiabank. Your line is now open.
Thank you very much, and thank you for taking my question. I just want to come back to some remarks, Helena, that you made when you talked about that you were a little bit disappointed in Hudson’s Bay’s performance. I think you were referring to the quarter, and that’s what I want to check here, when you said it had to do with having lower priced merchandise and that really impacted the basket. That merchandising issue, was that primarily related to Q4 or are you talking about the full year? Secondly, how did that happen? What prompted the decision to go for lower priced merchandise and how quickly can you shift that, or is that merchandising strategy extended into the buy that goes into F19?
Yes, okay great. Thanks Patricia. In particular we really--I’m focused on Q4 when I was talking about the performance, and I would say that just to give you context on how we got where we are, as you know, there was a big opportunity in 2018 and even before as Sears was closing their stores to go after that and really pull in Sears customers into our stores. Out of the gate, we did a really nice job with that. We saw nice performance in our stores that were located near Sears.
I think we took it too far, and so actually what we ended up doing was instead of focusing on lower price inventory for those customers shopping at Sears stores, we really took it across the chain. We saw this most noticeably in Q4 in terms of average basket being down, and the simplest way to think about it is in our premier locations, we were taking the best category of merchandise out of our stores and that led us to really look different, be not as differentiated as we wanted with the customer.
The good news about all of this is it’s fixable. This is not some foundational element that we can’t figure out. We’re on it, we have a new Chief Merchant who joined us in fourth quarter. I would say the real impact of the changes he and the team are making you’ll see in the second half of the year, but I actually feel very comfortable now that we know exactly what was driving it and that we’ve already made the strides to start to fix it.
Thank you, that was very helpful. That makes a lot of sense. For what it’s worth, it was noticeable in the stores.
Just a small follow-up there - you said the impact, certainly was the basket with respect to profitability. Did it do anything to units, or not really?
Not really, no. That was the unfortunate part of that. But to your point--
Yes, so at some level it’s exciting because we know it and we can go after it, and we already are.
Okay, thank you so much.
Thank you. Our next question comes from Sabahat Khan of RBC Capital Markets. Your line is now open.
Hey, this is Marcus on for Sabahat. Maybe just starting with capex for 2019, could you please provide some directional commentary on some of the major buckets that you think that will fall into?
Yes, as we look at SG&A, we felt we--or capex, sorry, as we look at capex, we felt we did a nice job with capex as well in 2018, reducing it significantly from the 2017 spend. As we move forward, as my guidance suggests, we’re going to see as a reduction again year-over-year. We will continue to invest in the stores and particularly in the Fifth Avenue as we continue to finish up that remodel and renovation. Obviously digital is an important thing for us, both with technology and fulfillment capabilities - we’re making investments there. I think some of the reductions you’ll see are actually in technology, where with our new CIO we’re really getting a lot of significant savings there, better pricing and better efficiencies, so we think we can actually spend less money in capex while driving additional projects and getting more for those dollars. That’s predominantly the savings you’ll see, but still significant investments in digital fulfillment and stores for the remainder.
All right, thanks. That’s helpful. Maybe could you talk a little bit about the outlook for Saks? The last few quarters have been quite strong, but what’s your outlook for the banner as we had into 2019 here?
As we looked at 2020, as Helena said, we’re very optimistic. We are coming off an over-five comp for Saks for the full year, and a significant part of that had the Fifth Avenue store under construction. While that construction continues moving forward, the first floor is now open and behind us, so we feel really optimistic about that. We haven’t seen any real signs of weakness there and we think the economy and the broader macro for the luxury market continues to be strong, and we’re optimistic about Saks moving forward.
Great, thanks. That’s all from me.
Thank you. As a reminder ladies and gentlemen, if you would like to ask a question, you may press star, one.
Our next question comes from Meaghen Annett of TD Securities. Your line is now open.
Thank you, good morning. Could you provide any color around the contribution to adjusted EBITDAR in fiscal ’18 from the stores that are anticipated to be closed next year, including the Lord & Taylor stores, the flagship, Saks Off Fifth, and Home Outfitters locations? Just as a follow-up, can you talk about the contribution to cash flow from those operations as well? That’d be helpful, thank you.
Sure. We’re still going through the process on Saks Off Fifth, we haven’t nailed down those 20 stores yet, but I would tell you that we were very marginally profitable in the Lord & Taylor Fifth Avenue location. We were unprofitable, as we stated, in the Home Outfitters, and our expectation is that the closings of the Saks Off Fifth will be accretive to EBITDA as we move forward, and EBITDAR. Our expectation is that all of those combined will be accretive to EBITDAR as we move forward, and accretive to EBITDA as well--or to cash flow as well.
Thank you. That concludes our question and answer session. Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.