Francesca’s Holdings Corporation (NASDAQ:FRAN) Q2 2020 Earnings Conference Call September 15, 2020 8:30 AM ET
Cindy Thomassee – Executive Vice President and Chief Financial Officer
Andrew Clarke – President and Chief Executive Officer
Conference Call Participants
Good morning. Welcome to Francesca’s Holdings Corporation’s Second Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded.
I will now turn the conference over to Cindy Thomassee to begin. Thank you.
Thanks. And good morning everyone. We appreciate your participation this morning in Francesca’s Second Quarter 2020 Conference Call.
Earlier today, we issued a press release announcing our second quarter financial results and exploration of strategic initiatives. 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 Form 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 our CEO, Andrew Clarke. I’ll now turn the call over to Andrew.
Thanks, Cindy. Good morning. And thank you for joining us for our second quarter earnings call.
As the challenges created by COVID-19 persist, we continue to control what is within our control in order to navigate through this difficult period. As such, we are managing our business to weather the short-term headwinds as well as advancing the strategies we have put in place to drive long-term growth.
Our near-term priorities have been focused on, first, the safety of our employees and customers. We continue to adhere to health and safety standards, the measures we began to employ in March in our corporate office, distribution centers, and our boutiques are still in place today. Our corporate teams are slowly coming back to the office under strict guidelines to protect their well-being, including temperature checks, social distancing and masks.
Second, we continue to drive sales and monetize inventory through our e-commerce business as well as reopened boutiques. E-commerce sales grew 27% over last year in the second quarter. Inventory at the end of the quarter was down 26% over last year.
We held a clearance sale the last week of July that helped us to end the quarter with substantially reduced clearance inventory, equivalent to 45% less versus the same period last year. This leaves us in a healthy inventory position to start the new season. With the continuation of work-from-home as well as schools-from-home, this fall, we are leveraging our rapid supply chain to lean into categories that align with our customers’ current lifestyle, which I will speak to shortly.
Third, the sustainability of our business as we continue to navigate through the pandemic. We remain maniacally focused on controlling costs, managing inventory and protecting our cash. We are reducing noncritical spending while continuing to work with vendors and landlords on payment terms.
Fourth, the safe reopening of our boutiques. We ended the quarter with 671 boutiques reopened, reflecting the reclosure of 29 boutiques in California due to the rising COVID cases there. The performance of our reopened boutiques largely aligns with the severity of the pandemic, and therefore, we are seeing a wide range of traffic trends across markets. While traffic remains challenging generally, we are encouraged by the improving conversion rate and AUR driven by her positive response to the new assortment, which is selling through at less discounted rates than our spring/summer offering.
Turning now to our strategies, our customer-centric approach remains the foundation of everything we do in terms of both our near-term and long-term strategies. Beginning with product, the agility of our business model is enabling us to quickly react to our customers’ preferences with the right product and exceptional value.
Leveraging our demand-driven sourcing model, we are pivoting our assortment to styles and categories that align with our customers’ current mindset and activities. We know that buy now and wear now is more important than ever. With loungewear, new tops and graphic tees, comfy bottoms, such as leggings and joggers, driving more recent apparel sales. With a shift in mindset towards casualization, we ramped up our casual pants business, which has proven to be the right strategy as we complement this with an enhanced casual fashion top assortment that is resonating with customers and driving higher UPTs through ease-of-outfitting opportunities.
Outside of apparel, footwear, including slippers, in addition to beauty products and a new category of COVID-related products, such as masks, blue light glasses and hand sanitizer, are the categories she is most favorably responding to. These categories are great examples of how we can quickly adjust our merchandise offering to meet the needs of our customers and drive strong conversion. Before we will continue to lean into these high-demand categories as she continues to prefer more casual styles.
We have successfully tested a loungewear assortment as we know this is becoming a more important of her wardrobe, and we want to grow our share of her closet. The team is chasing into this category based on strong initial results.
In addition to driving greater demand among our existing customers, we see opportunity to expand our reach due to the disruption in the marketplace. We have proven our ability to attract a younger customer to Francesca’s, evidenced by the double-digit growth in new customers during the quarter driven primarily by this demographic.
This fall, we will be testing a small assortment of tween products online and through our soon-to-launch app as well as extending our size offering online. While we are excited to see evidence of our ability to expand our reach, we remain devoted to our core customers. We know the style she loves, and we will continue to update these looks to refresh her closet and offer head to toe merchandise options. We have seen positive response to our merchandising strategies, and we’ll continue to use data to inform our merchandising decisions going forward.
Turning to our marketing strategy, we are taking a more localized approach than we have in the past. One of the differentiating attributes of Francesca’s is our small store format that project a local boutique aesthetic despite having a national presence. As such, we want to create more segmented messaging as opposed to a one-size-fits-all voice. We have a database of 2.6 million customers, and we will advance our data analytics capabilities to create messaging that speaks to different customers according to geography, demographic and channel preference to drive higher engagement. We have been trialing localized marketing and promotional strategies during the quarter to align with demand by market.
We are also amplifying our brand messaging in social media. Brand inclusivity will be a brand feature, woven throughout our assortments and marketing communication, and is a core value of our corporate culture. We recently enhanced our efforts on this latter point, establishing an associate diversity and inclusion council, which is actively engaged in helping us shape our future brand and company strategies.
In the last month of the second quarter and into the third quarter, we had decidedly pulled back on our promotions as we have cleared a large portion of our aged inventory. While this had impacted our top line, given the aggressive promotional environment, gross profit dollars and margin rate improved for this period. While we recognize that we have to be responsive to the promotional environment, we are challenging ourselves to maintain a less aggressive stance as new product assortments are now flowing to the boutiques and online on a weekly basis.
Turning to our boutiques, given that social distancing in a 1,400 square foot store is a challenge without a doubt. It is even more important that we optimize the boutique experience for our guests. We will continue to focus on delivering a broad end-use assortment with head-to-toe options that delight and excite her.
With traffic trends still significantly below last year, it is even more important that we drive conversion. We remain laser-focused on enhancing her omnichannel experience. We were very pleased with the performance of our e-commerce business during the store closure period, and we continue to pursue ways to enhance her online experience with us, both from a presentation and functionality perspective.
With the completion of the replatforming of our e-commerce site, we will be able to further advance our omnichannel capabilities. We currently expect to launch our mobile apps by the end of October to elevate her smartphone experience. While this is slightly later than we initially planned, we want her to enjoy a consistent and seamless experience; however she chooses to shop with us. We have had to play a bit of catch-up in this area, but we feel really good about the path we are on and the trajectory of this business.
In the second quarter, 74% of online customers were new to Francesca’s, visiting the brand for the first time through e-commerce. In addition, 67% of our e-commerce purchases are being made by existing customers from our boutique channel, who had not previously shopped us online. This remains encouraging, as I have previously said, as customers who shop multiple channels typically spend more than customers who shop a single channel.
In conclusion, we recognize the retail environment remains extremely challenged by the COVID pandemic, creating traffic pressures and highly aggressive promotions. While we have taken important steps to advance our strategic initiatives, we are operating within what continues to be an unprecedented and extremely challenging environment. As such, we believe it is in the best interest of our shareholders to explore a variety of potential strategic alternatives.
With the support of third-party consultants, we will be evaluating a number of alternatives, and we’ll provide an update once it is deemed appropriate to do so. While we cannot control many factors in this situation, I am proud of our team’s efforts in leveraging the agility of our business model, broadening our customer reach, enhancing our omnichannel experience and developing creative ways to capture opportunities through the market disruption.
Cash preservation remains paramount in the near term. Given the continued advancements we are making on the aforementioned strategies we have in place, our unique business model and the market share opportunities we see stemming from the disruption within the apparel retail space, we are optimistic about the long-term growth opportunities for Francesca’s.
I would like to turn it over to Cindy for our financial review.
Net sales for the second quarter decreased 29% to $75.7 million compared to $106 million in the second quarter last year due to the temporary closure of our boutiques and soft traffic trends in reopened boutiques as a result of the COVID-19 pandemic. As of September 4, 2020, only nine boutiques are still temporarily closed. This was partially offset by an increase in e-commerce sales, which were driven by strong conversion rates, partially offset by a decrease in average unit retail as a result of aggressive markdowns and promotions. Comparable sales declines moderated to a decrease of 5% versus the comparable prior period. In determining comparable sales change, sales for the period during which a boutique was temporarily closed for four or more days of a week were excluded.
In terms of performance by merchandise category, gift was our strongest category with comparable sales increasing, although total sales decreased, primarily driven by entertainment and candles. Apparel sales declined due to weakness in spring fashion tops and skirts, but was partially offset by continued strength in dresses. Jewelry sales declined with a decrease in all subcategories, which we attribute to the stay-at-home order in most parts of the country.
Accessories sales decreased due to decline in hair and sunglasses, partially offset by an increase in handbags. Gross profit as a percentage of sales for the period was 17.5% compared to 38.2% in the prior year. This unfavorable variance was primarily due to lower merchandise margin related to aggressive markdowns and permissions in order to move through aged inventory in boutiques during the temporary closure as well as to drive traffic to boutiques and online. As new merchandise flows into our boutiques, we have been less promotional and, therefore, expect merchandise margins to sequentially improve in the second half of the year.
Additionally, occupancy costs delevered as a result of lower sales but was partially offset by a decrease in lease and depreciation expenses, primarily due to prior year asset impairment charges. Our lease expense for the quarter included $1.2 million reduction related to early lease terminations triggered by kick out provisions as well as COVID-19-related lease abatements received from certain landlords.
SG&A expenses decreased $12.9 million or 33% to $26 million from $38.9 million in the prior year quarter. The decrease of SG&A was primarily due to $9.6 million decrease in boutique and corporate payroll costs as we operated boutiques with minimum coverage and temporarily furloughed substantially all of our employees during the portion of the quarter as well as $1.7 million decrease in boutique and corporate bonus expenses.
During the second quarter, the income tax expense was $4 million, while the effective tax rate was 30.2%. We expect that any net operating loss generated from tax purposes for fiscal year 2020 will be carried back to prior years as allowed under the CARES Act. And we will be entitled to an income tax refund when we file our fiscal year 2020 income tax return. An income tax benefit is currently reflected in our estimated annual effective tax rate for fiscal year 2020. The income tax benefit in the prior year quarter was immaterial due to the full valuation allowance provided on our net deferred tax assets during fiscal year 2019. Our net loss for the quarter was $17.2 million or $5.80 loss per diluted share. This compares to a net income of $1.8 million or $0.61 earnings per share in the prior year quarter.
Turning to the balance sheet. We ended the second quarter of 2020 with $20.2 million in cash and cash equivalents compared to $22 million at the end of the second quarter last year. As of August 1, 2020, our outstanding debt was $12.1 million, net of $0.9 million debt issuance costs. And our combined borrowing availability was $1 million under our credit facility.
Subsequent to quarter end, and as of September 4, 2020, our cash balance was $18.2 million. As of the same date, we had combined outstanding borrowings of $12.2 million, net of $0.8 million of debt issuance costs and $3 million of combined borrowing availability under our credit facility. Inventory on hand at the end of the second quarter was $22.9 million, a decrease of 26% as compared to the end of the second quarter last year.
Average inventory per boutique was down 24% from the prior-year quarter due to more clearance merchandise sold than merchandise received as a result of vendor supply disruptions caused by the COVID-19 pandemic. Our primary focus will be to continue to manage inventory levels conservatively as well as to leverage our flexible supply chain by working with our vendors to appropriately align inventory with demand as we emerge from this crisis.
Our year-to-date capital expenditures totaled $1.3 million comprised of $0.6 million for new boutiques, $0.4 million for boutique relocations and $0.3 million for technology initiatives, mostly associated with obtaining perpetual licenses. Note that the spending for new and relocated boutiques were committed prior to the COVID-19 pandemic.
During the second quarter, we opened one new boutique and permanently closed four boutiques, bringing the total boutique count to 700 at the end of the quarter, consisting of 339 malls and 361 non-mall locations, of which 92 are outlet boutiques. Our main priority continues to be building liquidity and preserving cash to manage through this crisis.
To that end, we continue to take aggressive and prudent action to optimize sales, monetize inventory, reduce expenses and manage liquidity. As Andrew mentioned, we are exploring a broad range of strategic alternatives, including: further lease concessions and deferrals, further reductions of operating and capital expenditures, raising additional capital, including seeking refinancing of our debt and restructuring our debt and liabilities through a private restructuring or restructuring under the protection of applicable bankruptcy laws.
Our strategic plans are not yet finalized and are subject to numerous uncertainties, including negotiations with creditors and investors and conditions in the credit and capital markets. We do not intend to disclose further developments unless and until the Board of Directors’ special committee has approved a specific transaction or otherwise determined that disclosure is appropriate.
This concludes the financial review, and I’ll now turn the call back over to Andrew for his closing remarks.
Thank you, Cindy.
Thank you for joining, and we look forward to updating you on our next call. In the meantime, we hope you remain healthy and safe.
Thank you. This does conclude the conference. You may disconnect your lines at this time, and have a wonderful day.