Ascena Retail Group's (ASNA) CEO Gary Muto on Q3 2019 Results - Earnings Call Transcript

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About: Ascena Retail Group, Inc. (ASNA)
by: SA Transcripts
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Earning Call Audio

Ascena Retail Group, Inc. (NASDAQ:ASNA) Q3 2019 Earnings Conference Call June 10, 2019 4:30 PM ET

Company Participants

Jennifer Davis - IR, ICR, Inc.

Carrie Teffner - Interim Executive Chair

Gary Muto - President and Chief Executive Officer

Robb Giammatteo - Chief Financial Officer

Conference Call Participants

Susan Anderson - B. Riley FBR

Dana Telsey - Telsey Advisor Group

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2019 Ascena Retail Group Earnings Conference 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] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Jennifer Davis of ICR. You may begin.

Jennifer Davis

Thank you. Good afternoon, and welcome to Ascena's third 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 June 10, 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 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.

Participating in today's call are Carrie Teffner, Interim Executive Chair, Gary Muto, Chief Executive Officer and Robb Giammatteo, Chief Financial Officer.

Thank you and I will now hand the call over to Carrie.

Carrie Teffner

Thank you, Jen. As you know, the Board and management have been quite active over the past several months. We have been working together to transform the company and return Ascena a profitable and sustainable top-line growth.

The process has been exhaustive and objective and it continues. Our focus has been and will be on creating value for our investors while at the same time being cognizant and respectful of the needs of our other stakeholders including our employees, suppliers, landlords and of course our customers.

The recent leadership changes were made by the Board to create a clear point of CEO accountability led by Gary, a brand-focused CEO. The entire Board and I have complete confidence in Gary’s ability to lead Ascena back to profitable growth. Gary is a seasoned leader with extensive women’s retail experience who has led the Ascena brand for the last few years.

Over the last ten years, he has grown LOFT to become one of the top women’s apparel brands, stabilized Ann Taylor, and launched Lou & Grey, a new women’s casual brand.

Prior to this, Gary spent over 20 years in leadership roles with Gap Inc. including President of Banana Republic and the Gap Brand. As Interim Executive Chair, I will work with Gary to drive the transformation necessary to create a brand portfolio and operating model that will deliver growth and profitability.

With respect to our efforts to transform and simplify the business, we have made meaningful progress on our comprehensive assessment of Ascena’s portfolio of brands with the successfully completed divestiture of Maurices and the announced wind down of the Dressbarn brand, we have essentially exited our value segments which has consistently underperformed expectations and generated substantial losses over the past two years.

While we continue our portfolio assessment, we are focused on addressing the company’s overall cost structure. There has been significant work done with change for growth initiatives that began in 2016, but that initiative was executed against the backdrop of building a plug and play platform to support a portfolio of business that was intended to be much larger than Ascena is now.

Today, Ascena is a business with fewer stronger brands that has the potential to deliver better than industry level growth and profitability and it is through this radically different lens that we will drive additional cost rationalization efforts to right size the corporate overhead structure to support a stronger focused more profitable business.

We have a lot of work ahead of us and I am confident that we have the right plan and the right team in place to make that happen. I look forward to updating you on our progress in the upcoming quarters and now I will turn the call over to Gary.

Gary Muto

Thank you, Carrie. First and foremost, I want to thank the entire Board for the confidence they have placed in me. I assure their commitment to restore the company through a growth trajectory and to generate value for our shareholders.

Let me start by taking a moment to highlight the strength of our brands. Ann Taylor, LOFT, Justice and Lane Bryant are some of the most iconic brands in retailing. Based on [MPP] [ph] data, both Ann Taylor and LOFT have almost universal awareness, and LOFT is the highest ranked women’s apparel specialty retail. Justice is the number one specialty player in girls’ apparel, and Lane Bryant is the number one specialty player in women's Plus apparel.

Our customers love our brands, they are loyal and we are well positioned to capitalize on these strong brand equities.

The transformation process that Carrie mentioned is well under way. We have taken steps to simplify our operating model and with the elimination of our Value segment, we are realigning our financial human capital to support the areas of the business with the greatest growth potential.

We have identified three strategic pillars to drive profitable growth, leveraging customer insights to inform strategy, implementing advanced analytics to drive productivity and leveraging our customer experience management capabilities to enhance personalization.

Our priority is to realize value across all three pillars as quickly as possible by introducing new functionality in shorter, continuous improvement cycles. With respect to consumer insights, over the past year, we have developed capabilities that translate customer feedback and market intelligence into actionable product and brand strategies. Use case examples include the existing Ann Taylor wear-to-work strategy and the refined Justice back-to-school offering.

Advanced analytics is a key enabler to margin rate accretion and improved inventory productivity representing opportunity for significant near-term value creation. We will implement promotional optimization at LOFT starting this fall. The remaining brands will follow along with expanded capabilities as we move throughout Spring 2020.

In the area of personalization, our new suite of customer experience management tools comes online later this summer at our Plus segment. This suite of tools enables detailed customer segmentation and personalization including real-time customer, traders to optimize the time, content, offer and design of every customer touch points. We will utilize learnings from our plus segment implementation to inform the rollout of our remaining brands.

Now let me provide some color on the performance of our brands during the third quarter, and then Rob will take you through the results in more detail. Our third quarter results reflects industry-wide headwinds. That said, our results were better than we had expected with flat enterprise-level comparable sales driven by our digital channel.

As we mentioned on our last earnings call, February was challenging but business improved over the combined March, April period. While sales came in ahead of our expectations, gross margins were towards the lower end of our range as we increased promotional activity to address soft traffic trends in elevated inventory levels.

Quarter end inventory levels were elevated as a result of unfavorable changes in comp trend versus the fall season when the inventory commitments were made. We are taking the appropriate action to return to more conservative inventory management process that will reduce our reliance on promotions and drive sales at healthier margins.

Turning to our operating segment. Our premium segments delivered 5% comparable sales growth with both Ann Taylor and LOFT posting similar increases. Ann Taylor delivered both comp sales and margin growth for the quarter driven by our full price business with specific strength in our structured apparel and accessory categories.

At LOFT where we drove positive comps, margin declines happened as we cleared underperforming early spring receipts. We continue to see growth at Ann Taylor factory and LOFT Outlet driven by our new digital channel for both brands which achieved high teen penetration for the quarter. In our Plus segment, Lane Bryant delivered a significant sequential improvement in the third quarter with comps down two versus a 8% decline in the prior quarter.

Margin rates were down through clearance of underperforming top assortment. Comp performance improved with the quarter as customers responded to assortment adjustments. Gradual improvements should continue through the summer. We continue to build on the strength we have seen in dresses and denim, which comped positively again the third quarter.

Additionally, we saw improved performance activity as the inventory levels were more perfectly balanced between fashion and basics.

Turning to our kids segment, Justice comps were down mid-single digits. Traffic did not accelerate as planned coming out of February with the pre-Easter period is especially disappointing. Margin rates were down as we were forced to address inventory build ups related to underperforming early spring receipts. We are refining our assortment architecture and we recognize the opportunity to continue to deliver newness and stay ahead of trends, as well as expand our offering within our opening price points.

Across our brands, customer mindset is changing which requires us to reevaluate assortment strategies for the transitional early spring period. The spring season is starting later and the transition month has become more challenging.

The customer is engaging with our brands over a longer timeframe and we must balance newness and wear now with wear forward fashion. Our teams are reassessing early spring assortment content along with the change in inventory flow to more closely match emerging customer patterns. While we have worked to accelerate topline growth from our more focused brand portfolio, we continue to drive meaningful structural cost reduction.

Beyond the $300 million savings from our change for growth program, we have identified an additional $150 million opportunity. We expect the majority of these incremental savings to be realized in fiscal 2020 and we continue to seek further cost reduction opportunities on an ongoing basis.

We have great brands in our portfolio and as CEO it’s my job to deliver the growth to profitability that we know we are capable of. We have a highly committed and engaged workforce that is focused on achieving our plans and I look forward to reporting back on our progress against these priorities in coming quarters.

And now I'll turn the call over to Robb.

Robb Giammatteo

Thanks, Gary and good afternoon everyone. I want to highlight the comments on this call will reference non-GAAP results, which exclude restructuring expenses and non-cash impairment of goodwill, other intangible assets and store-related fixed assets.

In addition Maurice’s results have been classified as discontinued operations for the quarter which impacts comparability of certain line items versus our guidance. 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.

Before I discuss third quarter results, let me touch briefly on the Dressbarn wind down. We are still in the early phase of discussions with key constituents and while we expect the process to be completed by the end of the calendar year, we are not prepared to share further detail at this time. We will provide updates on the process as we can.

In the interim period, our Dressbarn team is focused on continuing to service customers and assisting impacted associates in their transition.

Now turning to results. Our third quarter EPS performance exceeded our guidance due to better than expected comp sales performance. We experienced an adjusted loss of $0.26 per share resulting from gross margin rates that were well below historical levels, compounded by the deleveraging effect of Q3 as our lowest volume quarter. Excluding Maurices, total company com sales were flat with low single-digit growth and average dollar sales offset by reduced transactions.

High-teen transaction growth in the direct channel was more than offset by a 6% decline in the store channel. Third quarter direct penetration was approximately 32% of net sales, reflecting an approximate five percentage point increase from fiscal 2018 driven by continued comp transaction growth along with the new digital channels for Ann Taylor factory and LOFT outlets.

Total revenue from continuing operations of $1.266 billion was flat to the year-ago period with the favorable impact of the 53rd week timing shift offset by a lower store count resulting from our fleet optimization work.

Gross margin rate from continuing operations was 57.1% which was down 240 basis points to last year. We experienced rate declines at all of our operating segments caused by the higher promotional activity to address elevated inventory levels, and soft spring selling at our premium and kids segments, along with clearance of the underperforming top assortment of Lane Bryant coming out of the fall season.

Operating expense of $719million was up $29 million or 4.2% for the quarter, which was in line with our guide. The increase compared to the year ago period was caused primarily by inflationary pressure, initial spending and e elevated professional fees related to the company's ongoing portfolio evaluation and technology migration. These impacts were partially offset by store closures and transformation-related savings.

Touching briefly on our fleet optimization program, excluding Maurices, we had 24 net store closures in the third quarter and ended the quarter with 3519 stores inclusive of 661 Dressbarn stores, which will ultimately close as part of the brand’s announced wind down.

Turning to our balance sheet, we ended the third quarter with $101 million in cash and cash equivalents and total debt of $1.372 billion representing the balance of our term loan. Our quarter end cash balance excludes proceeds of approximately $210 million related to the Maurices transaction which closed shortly after quarter end.

While we remain focused on deleveraging our balance sheet, we were using these proceeds to support ongoing business operations while maintaining appropriate financial flexibility. 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 $575 million in liquidity at quarter end. Inclusive of Maurices performance, net debt was 3.6 times trailing 12 months EBITDA.

At the total company level, we exited the third quarter with inventory of $654 million, which is up 16% from the year ago period. Approximately one-third of the increase was related to early receipts and the new revenue recognition standards with the remainder caused by a decline in comp sales trends at the Premium and Kids segments compared to the time at which inventory was bought. The higher level of promotional activity that we expect will be needed to clear elevated inventory levels at our Premium and Kids segments is reflected in our outlook for the fourth quarter gross margin rates which I will speak to in a moment.

As Gary mentioned, we are returning to a more conservative approach to inventory management that will allow us to opportunistically chase upside while minimizing risk related to traffic volatility. Please reference Slide 5 of our supplemental package for additional inventory detail.

Capital expenditures for the third quarter were $34 million, and we now our estimate fiscal 2019 full year capital expenditures in a range of $150 million to $160 million.

Turning to our fourth quarter, due to volatility that we expect in total consolidated results related to the ongoing wind down of our Dressbarn business, we are providing net sales, gross margin and operating income guidance for the consolidated continuing operations of our Premium, Plus and Kids segments.

On that basis, we expect net sales of $1.175 billion to $1.215 billion with comparable sales down low to mid-single-digits. The comparable sales guidance reflects our quarter-to-date performance and is consistent with the challenging conditions that have been widely reported across our competitive space.

We expect gross margin rate in the range of 55% to 55.5% with the midpoint down approximately 320 basis points from the year ago period reflecting expected markdown activity that will be required to address elevated inventory levels and May performance.

And finally, we expect an operating loss of $15 million to operating income of $5 million versus operating income of $34 million in the prior year. We are providing an adjusted view with the past few full fiscal years total company performance excluding the Value segment in slide 11 of our supplemental package that illustrates the underlying financials of our more focused brand portfolio following completion of the Maurices divestiture and Dressbarn wind down.

As Gary said earlier, we are focused on restoring the company to growth trajectory and generating value for our shareholders with the closing of our Maurices transaction, the announcement of our intent to wind down operations of Dressbarn, our recent leadership transition and our additional cost take out plans, we’ve taken multiple steps toward effectively repositioning Ascena as a stronger, more focused competitor.

That concludes our prepared remarks and we’ll now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we have a question from Susan Anderson with B. Riley FBR. Your line is open

Susan Anderson

Hi, good evening. Thanks for taking my question and nice job on the quarter. I guess, now with the sale of Maurices and the wind down of Dressbarn, maybe if you could talk a little bit about how you feel about the rest of the brand portfolio and the health there.

It sounds like you feel like the rest of the brand portfolio obviously has a very loyal customer and strong customer following. So, I guess, I am just curious if you are looking to make any further changes there or just looking to continue to improve performance? Thanks.

Gary Muto

Susan, it’s Gary. As I mentioned on my – in my comments, the remaining portfolio they are iconic brands. If you look at LOFT and Ann Taylor, and you look at the brand awareness, you look at LOFT’s position in the marketplace, same thing for Justice and Lane Bryant. I think our opportunity is to really focus on the customer and the product and making sure that we are surprising and delighting her every step of the way. We are always going to look for new opportunities for organic growth in those brands, but I think the most important thing is to make sure that we have a strong foundation in the base businesses.

Carrie Teffner

I think the only thing I had - this is Carrie. I completely agree with everything Gary said I think the one addition is that, our portfolio review is ongoing and as we have more to say on that, we will share that with you.

Susan Anderson

Great. Okay. And then, maybe just a couple of follow-ups. I guess, on Justice, that was the one the kind of stood out to me, that was maybe a little bit lighter. You talked a little bit about what's going on there. But may be just talk about kind of the timeframe to get it back on track.

And then, also, on the inventory front, do you guys feel like your high I guess, across the entire brand portfolio or are there pockets of higher inventories at some brands, but not so much at the others? And then also, I guess, are you expecting to be cleaned by the end of this quarter for fall? Thanks.

Gary Muto

Susan, I’ll take the Justice question. Justice issue is really product-related. We’ve seen softness in apparel specifically in knits. It’s basically a carryover from the prior season. We see softness in Q2 as well as in Q3. The team is working aggressively to right size the inventory, right size the investment. Our goal is to get the apparel business back and we are looking to continue to reposition that inventory especially as we head into back-to-school.

Robb Giammatteo

Susan, it’s Robb. Just on the inventory question, yes we have pockets at Premium and at our Kids business. Again, those businesses have been trending very, very strong as you know in the second quarter when the inventory comments were made and we have had the trends decline there going through the third quarter. So we have backed up a bit in that area. Receipts are certainly planned down in the fourth quarter and we expect a higher unit velocity and is accounted for the promos and the markdowns we need to get out of that inventory. So it is our expectation to enter fiscal 2020 in a healthier position.

Susan Anderson

Got it. Okay, that’s very helpful. Thanks so much to you guys. Good luck next quarter.

Robb Giammatteo

Thank you.

Gary Muto

Thank you.

Operator

Thank you. Our next question comes from Dana Telsey with Telsey Advisor Group. Your line is open.

Dana Telsey

Hi. As you think about the gross margins that came this quarter and how you are planning, not only for the second quarter, but for the back half of the year? How do you think of the pushes and pulls by brand of how you are planning the business, whether it’s by new product introductions, marketing, or just how you see the gross margin progression – progressing by brands? Thank you.

Robb Giammatteo

Hi, Dana, it’s Robb. So, the…

Dana Telsey

Hi.

Robb Giammatteo

As we think about the year, so, we have had margin erosion due to some of the product missteps we had at a couple of the brands and due to the inventory challenges that we’ve had. So, if you think about recovery going forward without giving prescriptive guidance for fiscal 2020, you would expect that as we roll over some of these product missteps and then I'll get to Gary in a second.

We know that Lane Bryant has some significant missteps in the tops assortment in the fall season, we know that Justice had some fashion opportunities in some of their niche businesses. So we do expect that we would normalize some of that activity.

But the big challenge we have this year is we’ve had several hundred basis points of decline over the past couple of quarters and we’re expecting that in the fourth quarter as well, after we right size the inventory it really is about product execution at that point and that will be a big objective in fiscal 2020 to recover gross margin rates to historical levels.

One of the things we’ve had in the supplemental package, if you look at fiscal 2017 and fiscal 2018, we’ve been able to keep gross margin close to 59% and this year obviously has been a significant downside outlier for us. So, it’s our intent to recover that going forward in fiscal 2020.

Gary Muto

And I think we are much more fluid in our approach to inventory starting with receipts in Q4. I think it’s prudent for us to be very opportunistic to chase and then also leave money open for us. I think the biggest challenge we see is the headwinds we are facing with store traffic.

So, I think we are more – absolutely more liquid in our approach, we can absolutely realize better margins going forward. And Robb mentioned softness in Lane Bryant, specifically in Q1. And we’ve taken steps to remediate all those assortment issues and like I said the performance has improved sequentially as we move through the quarters and we feel that we are better positioned as we head into Q1.

Dana Telsey

And then, just following up on the incremental cost that you outlined in the press release. Where are those coming from? Over what period of time do you get the benefit of reducing those costs?

Gary Muto

So, Dana, it will be in fiscal 2020 and fiscal 2021 and the majority of it will be in fiscal 2020. So, the big chunks are going to come out of what we call operating model which is our workforce and non-merchandise procurement, again which are anything aside from merchandise assortment, all the traditional spend that we have in terms of historical expenses and travel and things of that nature, as well as some savings from continuing work with fleet optimization. So, again more than half of that will come in fiscal 2020 and we’ve actually actioned one of the large components in our operating model last week.

Dana Telsey

Thank you.

Gary Muto

You are welcome.

Operator

Thank you. [Operator Instructions]

Carrie Teffner

Okay, thank you. If there are no more calls, we will go ahead and end this call and we look forward to updating you further next quarter.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today’s program. You may all disconnect. Everyone, have a great day.