Francesca's Holdings Corporation (NASDAQ:FRAN) Q2 2019 Earnings Conference Call September 10, 2019 8:30 AM ET
Cindy Thomassee - EVP and CFO
Michael Prendergast - Interim CEO
Conference Call Participants
Greetings and welcome to the Francesca's Holdings Corporation Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder this conference is being recorded.
It is now my pleasure to introduce your host, Cindy Thomassee, Chief Financial Officer. Thank you. You may now begin.
Thank you, and good morning, everyone. We appreciate your participation this morning in Francesca's second quarter fiscal year 2019 conference call. Earlier this morning, we issued a press release outlining our financial and operating results for the second quarter ended August 3, 2019.
Please note the following discussion includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts included in today's discussion that address activities, events or developments that the company expects, believes, targets or anticipates will or may occur in the future are forward-looking statements.
The company's actual results may differ materially from those projected in the forward-looking statements as a result of certain risks or other factors, including those risk factors set forth in the company's 10-K and quarterly reports on Forms 10-Q filed with the Securities and Exchange Commission. All such statements speak only as of the date made, and except as required by law, the company undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.
As usual, a replay of today’s conference call will be posted on our corporate website. We will begin today’s call with comments from Interim CEO, Michael Prendergast. Michael?
Thank you, Cindy. We are very pleased to deliver meaningful sequential improvement in our results for the second quarter illustrating the advancements that we have made on the strategic turnaround plan, we introduced just two quarters ago. Our comparable sales decline of 5% reflects significant improvement from the 13% decrease we saw last quarter and double-digit declines delivered over the last nine quarters.
While we saw a declining gross margin attributable to the aggressive markdowns we took to move to legacy merchandise, partially offset by strong full price sell through of the new product our team has delivered, we also realized considerable costs savings at both the corporate and store level that is flowing to the bottom line and made progress in our efforts to optimize our real estate portfolio.
Overall, I am proud of how swiftly the entire organization has embraced our turnaround strategy and the hard work they have put into the execution of this plan. I want to thank them for their dedication and the contributions they have made thus far and look forward to the continued momentum.
With that backdrop, I would like to provide more color on our progress to achieve in regards to the five pillars of our previously stated strategic turnaround plan. First, enhancing our buying merchandising and planning activities, back to a read and react to customer demand model.
We are operating fully as a demand-based read-and-react business model to deliver a broad and shallow trend right assortment. We have accomplished this by employing simplified planning and buying principles, conducting weekly sales meetings to analyze selling trends, maintaining approximately 50% open to buy available on a monthly basis to chase into strong selling merchandise and reducing lead times down to on average between one to twelve weeks. These measures have provided us with the knowledge nimbleness and flexibility to successfully execute a fast fashion strategy.
The teams consistently look at best and worst sellers of the sell-through, margin and inventory position level weekly. They then react to future on order by advancing repurchasing, reducing, and adjusting through cancellations of product based on deep data analytics.
Last quarter, we discussed three successful programs and incorporated these initiatives. New and Now, a short shop and the flawless dress. I'm very pleased to share that the results have exceeded our expectations. The merchant team efforts delivered significant improvement in both the clothing and jewelry classifications.
For the quarter our dress in short subcategories posted positive comps after a long period of double-digit comp sales decline. In addition we saw strength in earrings and necklace category comp sales.
Second, aligning our product offering with customer demand. As I mentioned, we are leveraging our robust customer data and analytics to inform decisions around the product assortment. We're looking at a variety of factors to determine demand by category item, price point and fashion point of view. To succeed as a quick turn read-and-react model, it is critical to capture important selling and customer data in order to maintain an assortment that provides consistent newness and represents the latest trends.
By creating a flatter organization we have also empowered our merchant teams to identify and swiftly react to insights they're gaining in the marketplace, through attending trade shows, leveraging trend services or in working with the vendor community to identify recent fashion trends. They have successfully re-engaged their vendor partners and are leveraging their knowledge of successes, risks, trends and opportunities in the fashion markets.
We have also made changes in product allocation to ensure the inventory shift is appropriately aligned with individual store volume, as well as local tastes. For example, we know our Northeast regional customer has a strong preference for brighter colors, while we skew to more bohemian looks in our southern stores, all while maintaining Francesca's brand identity, regardless of where and how she chooses to shop.
Last week within the quarter, we began a robust analysis of our customer database and buying habits and have renovated our customer interface and marketing activities to enhance traffic and sales. As an example, we have expanded our ambassador and social media influencer programs based on engagement data and look forward to continued success in this area.
Third, reducing corporate expenses. We remain on track to achieve annualize savings of approximately $8 million in corporate overhead and third-party costs. We have also updated our daily, monthly and quarterly review processes, leading to strict corporate expense controls throughout the organization to ensure we operate a lean and efficient model. With the reduction enforced in February we have also benefited from being an organization that is leaner, flatter and quicker to make decisions.
Fourth, we have also reduced store operation and labor expenses. As previously mentioned at the store level we are maintaining a one-to-one staffing model that has yielded meaningful savings. Where we did see an uptick in expense to budget was in the bonus compensation as a result of sales performance exceeding goals, which we were pleased to see. As we approach the holiday season, as budgeted, we will look to increase store coverage in high volume doors in peak traffic periods. Overall, we continue to expect to yield approximately $7 million in annualized savings in store labor costs.
Fifth, optimizing our real estate portfolio. We've been pleased with the negotiation process so far, and look forward to continuing to work with our landlord partners. We have done a lot of work around calibrating the lease expense structure, with sales levels, and working with landlords on rent concessions.
Additionally, with the improvement in our store performance, we believe that the landlord partners have increased incentive to work with us on lease terms. We look forward to updating you on the future progress in our upcoming calls.
The area of business that we are working diligently to improve is our e-commerce channel. Our three areas of focus, are merchandising a product, internal processes, and site functionality. As you may recall, we had excess inventory that we needed to move through the first half of this year, a lot of which was done through our website. With the lion's share of our excess inventory now behind us we are focused on improving our online merchandise assortment to meet customer demand, and enhancing how the product is presented online.
In the past quarter e-com strategy for product offering was not 100% congruent with brick and mortar. And within quarter two, we changed and adjusted the strategy to be at least 100% congruent. We are also working on expanding our offering beyond what we offer in our boutiques, knowing that the e commerce customer has an appetite for online exclusives.
We have conducted extensive analysis in regards to our style, SKU, number of colors offered versus the sales and inventory productivity ratios to determine the correct level of additional offer needed. We will continue to diligently analyze these metrics and look for ways to enhance our customer selections, to what level of demand to determine on a classification and sub-classification basis.
In terms of processes, we've dramatically reduced the time it takes to upload new products onto our site. Previously, we operated an antiquated and complicated process for the photography, inventory, database entry and uploading of a style for example. We recognize that getting product on the site quickly is a critical component to our success, as we want to maintain a new and relevant fashion offering each time she visits our website and will continue to improve in this area.
Finally, we continue to look for ways to drive improved functionality to ensure that our customer experience online is just as exceptional as her brick and mortar shopping experience. This comes through in the look and feel of our site, and navigation as she shops and the speed of the checkout process.
Our efforts to improve e-commerce performance is already bearing fruit as we saw our July performance improve. Comp sales were positive, while traffic and conversion metrics were strong and improved from previous trends.
Lastly, we have made some structural changes in our marketing teams, and recently hired a veteran of Polo Ralph Lauren to help lead our creative efforts on a long term Interim Creative Director basis. She has done a terrific job in updating our brand point of view, which has been reflected across our website, store signage, and social media touch points.
Our marketing programs have three goals. One to increase engagement with existing customers. Two, win back lost customers; and three expand brand awareness. As mentioned we have recently we introduced influencer programs that we believe will help us to accomplish all of the above. In addition we have introduced other marketing initiatives, including enhanced in store signage and monthly traffic events in store.
Our social media engagement is up four to six times previous levels. And we are extremely excited about the direction of our marketing strategy. Importantly, we are focusing on more impactful marketing tools, while reducing overall marketing spend. Overall I'm extremely pleased with the swiftness in which we as a team have been able to effect change and drive sequential improvement in the business.
We believe that we are well positioned to build on our momentum in the second half of the year. We remain confident that the strategies we have in place will lead to stabilized financial performance and ultimately set us up to achieve long-term sustainable profitable growth.
With that I will turn the call over to Cindy to review our financial performance for the second quarter in more detail. Cindy?
Thanks, Michael. Our discussion today will primarily focus on a review of our second quarter 2019 adjusted financial results. I encourage you all to refer to our press release issued this morning for reconciliation of our GAAP results to be adjusted results.
Net sales for the second quarter decreased 6% to $106 million compared to $113 million in the second quarter last year due to a comparable sales decline of 5%. Our comp results reflect a meaningful improvement compared to the double-digit decline we experienced in the last few quarters. And looking at our sales performance on a monthly basis, May was challenging due to the large amount of legacy product on hand marked down in June.
However, once our new receipts landed, we saw a dramatic improvement in sales which led to better than expected performance in June, and in inflection point in July. The decrease in comparable sales for the quarter was the result of lower average unit retail associated with deeper markdowns taken to work through poor performing legacy products. This was partially offset by a high single-digit increase in boutique conversion rate and low single-digit increase in average units per transaction.
Both of these metrics showed improvement from the first quarter, with conversion rate improving dramatically from the mid-single digit decline. As we previously mentioned, we believe that an improvement in boutique conversion rate would be the first indication that our turnaround plan is working.
E-commerce sales were not as strong as expected due to the lack of new products and breadth in the online assortment. As Michael mentioned during his remarks, initiatives are underway to enhance our e-commerce shopping experience.
Gross margin for the period was 38.2% versus 39% in the prior year. The 80 basis point decline was due to lower merchandise margins as a result of deeper markdowns on legacy products and deleveraging of occupancy costs as a result of lower sales.
Despite the aggressive markdowns, the merchandise margin only slightly decreased as we did not have to take marked out of stock charges during the quarter as we did in the prior year. We were very pleased with the sales growth on products that reflects our go-forward strategy.
Adjusted SG&A decreased 11% to $38.7 million in the second quarter of fiscal year 2019 from $43.3 million in the same period last year. This decrease was mostly due to a $2.5 million decrease in boutique payroll and supplies associated with the company's cost reduction initiative under the turnaround plan.
The specific -- the additional decreases are as follows: $0.9 million decrease in corporate payroll and related expenses due to lower headcount; $0.4 million decrease in marketing expenses; and a $0.3 million decrease in asset write-off charges related to remodel boutique. Excluding the adjustments for SG&A, adjusted income from operations in the second quarter of fiscal year 2019 was $1.8 million, compared $0.8 million in the same period last year.
During the quarter, our income tax benefit was $0.3 million, compared to an income tax expense of $0.4 million in the prior year quarter. The income tax benefits recognized in the second quarter is based on a revised estimate of our annualized taxable income for fiscal year 2019. Our adjusted net income for the quarter was $2.1 million or $0.72 adjusted diluted earnings per share, which compares to a net income of $0.5 million or $0.16 diluted earnings per share in the prior year.
Now turning to the balance sheet, we ended the second quarter of 2019 with $22 million in cash, compared to $23.4 million at the end of second quarter last year. The company had $10 million in debt outstanding at the end of the quarter under our ABL with JPMorgan Chase. As at August 3, 2019, we had $10 million of borrowing availability under the ABL of which $4 million were available for borrowings before consideration of the fixed charge coverage ratio requirements.
As previously disclosed on August 13, 2019, we entered into a $10 million 3-year term loan with Tiger Financing LLC. We used the proceeds from the term loan to pay the $10 million outstanding under our existing ABL. As of August 31, 2019, we had approximately $16.3 million borrowing availability under our ABL. Note that the fixed charge coverage ratio requirement has been removed through an amendment of the ABL agreement.
Our capital expenditures for the year-to-date period totaled $3.4 million comprised of $1.6 million for remodel, $0.7 million for existing boutiques, $0.6 million for new boutique and $0.4 million for technology and corporate initiatives.
Note, that our spending for remodel related to payments of previously accrued construction costs, as we did not have any boutique remodels during the period. We have minimal planned CapEx for the remainder of fiscal year 2019, as our focus remains on the execution of our turnaround plan.
During the quarter we opened one new boutique and closed five, bringing our total boutique count to 718. We plan to open one more boutique in the third quarter. We now expect to close at least 10 existing boutiques for the remainder of 2019. The boutiques we expect to close are those with a negative contribution margin that are at the kick out period or at least in.
Overall, the progress we are making across strategic initiatives led to improved financial performance and we look forward to building on this momentum.
This concludes the financial review and I’ll now turn the call back over to Michael for his closing remarks.
Thank you, Cindy. In closing, I'd like to thank Cindy, and Senior Leadership team, and the entire organization for their hard work and dedication to executing the turnaround plan. We have accomplished a significant amount of improvements in a very short period of time, and I look forward to enhancing our performance and continuing the early momentum that we have created.
Thank you for your time today.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.