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Express (NYSE:EXPR)
Q3 2018 Earnings Conference Call
Nov. 29, 2018 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Emily and I will be your conference operator today. At this time, I would like to welcome everyone to the Express Incorporated third-quarter 2018 earnings conference call. [Operator instructions] Mark Rupe, vice president, investor relations, you may begin your conference.

Mark Rupe -- Investor Relations

Thanks, Emily. Good morning and welcome to our call. I'd like to open by reminding you of the company's safe harbor provisions. Any statements made during this conference call except those containing historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results may differ materially from those suggested in forward-looking statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC, including today's press release. Express assumes no obligation to update any forward-looking statements or information except as required by law. In addition, during this call we will make reference to adjusted net income and adjusted diluted earnings per share, which are non-GAAP measures. Information necessary to reconcile these non-GAAP measures can be found in our press release, which has been filed as an exhibit to our Form 8-K with the SEC and is available on the company's Investor Relations website.

Our comments today will supplement the detailed information provided in both the press release and the investor presentation. With me today are David Kornberg, president and CEO; Matt Moellering, executive vice president and COO; and Perry Pericleous, senior vice president and CFO. I will now turn the call over to David.

David Kornberg -- President and Chief Executive Officer

Thank you, Mark. Good morning and thank you for joining us. Our third-quarter performance was in line with our guidance. Third-quarter net sales increased 2% with flat comparable sales and earnings increased relative to the prior year with EPS of $0.11 versus $0.08 last year.

Some of the key highlights in the quarter included, on the women's side, we drove solid results in our wear-to-work and going-out assortments with above-average comp performance in dressy wear and tops, dressy pants, dresses, skirts, jackets, outerwear, and accessories. Another good performance in our men's business with strength in suits, casual pants, denim, knit tops and outerwear, and shirts improved during the quarter. We had strong performance in e-commerce with comparable sales increasing 23% on top of 23% growth in the same period a year ago. We saw increased benefit from our omni-channel capabilities with ship-from-store driving improved markdown optimization.

We achieved gross margin expansion of 70 basis points. And lastly, our balance sheet remains sound which allowed us to further our efforts in enhancing shareholder value through share repurchases during the period. So overall, our third-quarter performance was in line with our guidance. Now turning to the fourth quarter.

We entered the holiday season positioned to succeed with increased units as compared to last year. However, sales to date in November, including the recently completed Black Friday week, have been below our expectations. The apparel specialty retail environment continues to be highly promotional and our traffic has been challenging. As a result, we are revising our guidance to reflect a more cautious stance, given recent unexpected sales trends.

That said, a majority of the quarter is still in front of us and we are focused on improving the business trends and optimizing the results. I would now like to discuss our strategic goal, the most important of which is growing sales along with profitability. This is our most significant opportunity to drive shareholder value. On last quarter's call, we established the goal of returning the business to a mid-single digit operating margin over the next three years or by 2021.

And while we are disappointed that our fourth-quarter outlook represents a step back in our pursuit of this goal, it still represents the most important goal and one that our entire team is focused on. To achieve it, we need to return the business to positive low single-digit comparable sales growth, expand gross margin, and leverage SG&A expenses. And this requires successful execution across four key areas: first is growing our customer base through increased customer acquisition and retention; second is driving retail sales through double-digit e-commerce growth while improving overall store productivity; third is realizing the benefits from our systems investments and omni-channel capabilities; and fourth is effectively managing our costs. As it relates to the first area, growing our customer base, Express is already a relevant fashion brand with millions of active customers but we see an opportunity to grow our customer base and increase its overall productivity.

To capitalize, we need consistent product execution, effective marketing, and a continuous and holistic brand and customer experience across all channels. In terms of product, it is central to everything we do and there are many areas where we are doing it well. In our key wear-to-work and going-out offerings, where Express is a recognized leader, we are succeeding. We are pleased that we have been able to return our men's business to growth driven by a number of categories, including suits, knit tops, denim, and casual pants.

And on the women's side we were able to turn around our performance in dresses and dressy woven tops in the third quarter. We have also done a good job expanding our assortment to serve more customers, which is driving customer acquisition. We have increased the number of choices online and remain pleased with our launch of extended sizes online and in 130 stores. That said, we have an opportunity to improve trends within our women's casual business and have several new initiatives planned for 2019 to drive improved trends.

As it relates to marketing, we are investing in initiatives designed to improve our effectiveness in driving customer acquisition. On the women's side, we are excited about several new design collaborations lined up for 2019 that we believe will increase interest in Express. We are partnering with Olivia Culpo to launch a co-designed capsule collection in late January. Olivia is a highly talented and widely followed model and fashion influencer that we believe will introduce Express to many new customers.

In addition, we are continuing our partnership with Karlie Kloss. She is prominently featured in our holiday campaign and will continue to represent the brand in a deeper way in 2019. And on the men's side, we are continuing our successful relationship with the NBA in five players. We recently introduced NBA licensed fleece and graphic tees online and in over 150 stores.

And in March, we will expand the assortment to include dressy apparel, including shirts, blazers, and ties. This represents a unique proposition in the market and will differentiate the Express brand. We are optimistic that our partnership with the NBA will continue to positively influence our men's business. Our Express Next loyalty program and credit card are also very important acquisition and retention tools for the brand.

We have well defined membership and participation goals for each and continue to be pleased with how we are tracking against them. That said, we see an opportunity to improve the productivity of our existing member base as well as the traction with our non-loyalty customers, and early next year we'll introduce new programs designed to increase brand engagement. We are also actively focused on growing our customer base through new channels, such as our new subscription-based rental service, Express Style Trial, as well as B2B initiatives. And third, we must continue to deliver our holistic brand and customer experience across all channels to grow our customer base.

In the past few years, we have done a good job enhancing our e-commerce, mobile, and in-store capabilities to ensure we are providing an experience that meets our customers' expectations, and this will remain a priority going forward. We are currently piloting Express Rapid Return in four markets to take friction out of the shopping experience by allowing customers to return items with any associate on the sales floor. We've also recently launched Digital Style Chat, where we provide online real-time style advice to improve the online shopping experience. These are just a few of the many initiatives we are working on.

To summarize the first area, we're making progress in growing our customer base. That said, we believe there is more runway, and I'm confident that our initiatives across product, marketing, and customer experience will translate into customer growth over the next several years. The second area is driving retail sales through double-digit e-commerce growth while improving overall store productivity. We have executed well in e-commerce.

Comparable sales growth remains strong in the third quarter, growing 23% year over year on top of the 23% growth experienced in the prior year. And as a percentage of sales e-commerce accounted for 29% of net sales, up from 23% in the prior year. Ecommerce sales benefited from increased mobile penetration and our expanded omni-channel capabilities. As it relates to stores, we have a significant opportunity to improve overall productivity, and most notably, in our full price retail stores where traffic declines continue to be the primary pressure point.

To address traffic, we are laser focused on delivering compelling products from a fashion point of view and a relevant brand and marketing message to drive customer acquisition and retention. Footprint optimization is also important to improving store productivity, and we have accomplished a great deal on this front in recent years. During the third quarter, we converted two additional retail stores to outlets, completing our 2018 plan of 29 conversions. We have converted more than 60 retail stores to the outlet format in the past two years and are evaluating the potential for additional conversions based on the productivity gains experienced in these locations.

We are also testing two new store formats. The first one is at our 51st and Madison store in New York City, where we have a curated assortment of wear-to-work and going-out product, and also personalizes styling services. We have applied the learnings from this store to 10 additional locations in the third quarter. In addition, we just reopened our Cherry Creek store in Denver with a new format.

The new store builds on learnings from 51st and Madison, offering customers differentiated and elevated shopping experience and new customer-facing technology. Store features include omni-service, styling, personalization, digital signage, and styling touch screens. We are optimistic that this new store design can unlock an opportunity to drive in-store traffic and customer acquisition over time. From an outlet perspective, we are seeing good results from our tests in off-mall power centers.

We have opened four stores to date, and based on their performance, are considering additional locations. We look forward to sharing more on each of these in the future. So to summarize the second area, e-commerce sales growth remained strong in the third quarter and we continue to be pleased with outlet store productivity while focusing on the performance of our full-price retail stores. The third area, where we need to be successful in order to drive improved profitability, is capturing the benefits from our systems investments and omni-channel capabilities.

We are pleased with the benefits our omni-channel capabilities are beginning to deliver. We were able to take fewer items to sell during Q3 as compared to last year, which benefited merchandise margin during the quarter. We also expect our recently completed upgrade of our store point-of-sale system to improve in-store transaction efficiency. And lastly, we are in the early phases of implementation of our new assortment planning software and currently expect to complete it by the end of 2019.

So to summarize the third area, we are realizing benefits from our systems investments and omni-channel capabilities but remain in the early innings. We look forward to updating you on our continued progress in upcoming quarters. And lastly, the fourth area is effectively managing our costs. We remain on track to achieve the $44 million to $54 million total cost savings target by the end of 2019.

And separately, we are benefiting from reduced occupancy costs, which are expected to continue based on recent lease negotiations and the significant flexibility we have with respect to approximately 60% of our retail leases up for renewal in the next three years. So in conclusion, we are making significant progress across many of our key initiatives and have delivered results in line with our expectations through the first three quarters of 2018. While the fourth quarter has started below our expectations, we are focused on improving the business trends and are optimizing the results during the remainder of the quarter. We continue to believe strongly in the long-term direction of our business and our thoughtful capital allocation over the past year underscores this confidence.

Under our current $150 million share repurchase program, we have repurchased 10.6 million shares for $91 million, and we continue to have $59 million remaining available. I would like to close by thanking everyone at Express for their ongoing hard work and commitment to the brand. I look forward to providing an update on our results in 2019. I would now like to turn the call over to Perry.

Perry Pericleous -- Senior Vice President and Chief Financial Officer

Thank you, David. Good morning, everyone. I'm going to start by reviewing our third-quarter results, followed by a discussion of our fourth quarter and fiscal 2018 outlook. Third-quarter net sales were $515 million, a 2% increase as compared to $503 million last year.

Comparable sales were flat with 23% e-commerce comp growth and store comps of negative 7%. Our third-quarter gross profit was $158 million, an improvement of $7 million compared to the prior year. Third-quarter gross margin was 30.7% and expanded by 70 basis points compared to the prior year. Merchandise margin expanded by 10 basis points, driven by our ship-from-store capability, which lowered our clearance inventory during the quarter, partially offset by higher shipping costs and increased promotional activity.

However, merchandise margin was lower than we initially anticipated due to the increased promotional activity during the quarter. Buying and occupancy costs as a percentage of net sales improved by 60 basis points due to increased net sales and favorable lease renewals. This improvement was partially offset by higher fulfillment costs related to the significant growth in e-commerce sales. SG&A expenses were $148 million, up $8 million, and as a percentage of sales increased 90 basis points as compared to last year's 28.8%.

The increase relative to last year was driven primarily by marketing and wage inflationary costs. Operating income was $10.2 million or 2% of sales as compared to last year's operating income of $10.8 million. And third-quarter earnings per diluted share were $0.11, an improvement from last year's EPS of $0.08. Now turning to our balance sheet and cash flow, our balance sheet remains healthy.

We ended the quarter with $161 million of cash and cash equivalents as compared to last year's $198 million. The decline versus last year is primarily due to $73 million of share repurchases. Inventories at quarter-end were $363 million, an 8% increase as compared to last year's $337 million. As we indicated on last quarter's call, the increase was anticipated and driven primarily by the shift in the retail calendar and the fact that Black Friday week fell in the third week of November this year.

We expect inventory to return to a more normalized level by the end of the fourth quarter. Year-to-date capital expenditures were $32 million, down from $42 million last year. In terms of our share repurchase program, we repurchased 2.5 million shares for $24.2 million during the third quarter, and subsequent to quarter end, have repurchased an additional 2 million shares for approximately $17.1 million. Under our current $150 million share repurchase program, we have repurchased 10.6 million shares for $91 million and we continue to have $59 million remaining available.With that, I will now address our guidance for the fourth quarter and full year.

For the fourth quarter of 2018, we currently expect comparable sales in the range of negative 5% to negative 7%, net income in the range of $8 million to $14 million, and earnings per diluted share in the range of $0.11 to $0.12. This compares to last year's adjusted diluted EPS of $0.33, which includes $0.04 from the 53rd week. It is important to remember that the fourth-quarter net sales will be impacted by last year's 53rd week and the shift in the retail calendar, where a larger week in November is replaced with a smaller week in January. As we highlighted on last quarter's call, these two items are expected to impact fourth-quarter net sales by approximately 5 percentage points, with last year's 53rd week being the primary driver.

And just to be clear, this does not impact comparable sales and has always been contemplated in our guidance. Turning to our full-year 2018 guidance, we currently expect comparable sales in the range of negative 1% to negative 2%, net income in the range of $18.5 million to $24.5 million, and earnings per diluted share in the range of $0.25 to $0.33. This compares to last year's adjusted diluted EPS of $0.37, which includes $0.04 from the 53rd week. As it relates to capital expenditures, we plan to spend approximately $53 million to $58 million in 2018.

In terms of cash flow, our guidance assumes continued positive free cash flow generation in 2018. Before closing, I would like to provide a brief update on one additional item. As we discussed on last quarter's call, the lines between our retail stores and e-commerce channel are becoming increasingly intertwined due to the continued success and expansion of our omni-channel capabilities. We are continuing to evaluate our reporting approach as it relates to comparable store sales and e-commerce sales, and we will provide an update on our fourth-quarter earnings call in early March.

With that said, in summary, we're highly focused on executing during the remainder of the holiday season and remain committed to driving improved profitability. We look forward to updating you on our progress in 2019. I would now like to turn the call over to the operator to begin the question-and-answer portion of the call. 

Questions and Answers:

Operator

[Operator instructions] Your first question comes from Paul Trussell with Deutsche Bank. Your line is open.

Gabby Carbone -- Deutsche Bank -- Analyst

Hi, good morning. This is Gabby Carbone on for Paul. Thanks for taking our question. You mentioned in your prepared remarks that quarter sales trends have been unexpected.

If you could just elaborate on that. What are you seeing in November and if you're currently running in line with the comp guidance for the full quarter? Thanks.

David Kornberg -- President and Chief Executive Officer

Hi, Gabby. David. Traffic -- what I would say is traffic has been challenging across the business, which has pressured sales in November. We have seen, I would say, a more significant deceleration in women's than we've seen in men's.

In the third quarter, we had a really good quarter in dresses and dressy woven tops. However, we have seen both categories slow down in November, the beginning of November. And then in addition, sweaters quarter-to-date are not performing to our expectations. So what we're seeing overall is really sales pressure has been across the business, including by channel.

Gabby Carbone -- Deutsche Bank -- Analyst

Thanks. So just a quick follow-up, you mentioned that you're comfortable with your inventory levels, given the calendar shift, but other categories you're are currently sitting higher end than you would like moving into the fourth quarter?

Perry Pericleous -- Senior Vice President and Chief Financial Officer

So from an inventory standpoint, as we've mentioned back in -- during the September call, we were comfortable and we were expecting that the inventory levels would be elevated driven -- given the shift in the retail calendar. Now, given the current guidance that we're providing, we're assuming that you can see that from our operating margin expectations for the quarter that we're expecting that we're going to be clearing through that excess inventory throughout the quarter, and we expect that by the end of the quarter to be at more normalized levels.

Gabby Carbone -- Deutsche Bank -- Analyst

OK. Great. Thanks.

Perry Pericleous -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from Susan Anderson with B. Riley FBR. Your line is open.

Susan Anderson -- B. Riley FBR, Inc. -- Analyst

Hi, good morning. Thanks for taking my question. I was wondering maybe if you could give a little bit more color around, I guess, the start of fourth quarter and Black Friday. It sounds like it's maybe a little bit more promotional than you expected.

Did you have maybe kind of a step-up also in compares during that period last year, I guess? Just trying to figure out the big step down in the comps that you were seeing from third quarter.

Perry Pericleous -- Senior Vice President and Chief Financial Officer

Susan, our -- what we're seeing during Black Friday and the first three weeks of November, as mentioned -- as David mentioned earlier, is a deceleration mainly in the women's business but overall across the board, driven by traffic that we have seen across the business. The compares, we don't discuss the compares intra-quarter as it relates to last year, but the current guidance that we're providing for the quarter of negative 5% to negative 7% embeds what we have seen the first three weeks of November and what we believe we can achieve the balance of the quarter.

Susan Anderson -- B. Riley FBR, Inc. -- Analyst

OK. Got it. Maybe if you could talk about -- also just curious the performance in denim in the quarter. I think before you had talked about maybe being under-inventoried and could have captured more sales.

Was third quarter, I guess, better in line with inventory, and did you see better performance in denim?

David Kornberg -- President and Chief Executive Officer

What we saw is we saw it improve as we went into the second quarter. Q3, we didn't mention it, is one of our highlights for the third quarter. But what we're seeing is we're seeing obviously the strength continuing in leggings and we're seeing some progress in terms of new leg shapes coming in, which are making a difference. In terms of men's, denim was very good in Q3.

Susan Anderson -- B. Riley FBR, Inc. -- Analyst

OK. Great. That's helpful. Thanks so much.

Good luck next quarter.

David Kornberg -- President and Chief Executive Officer

Thank you.

Perry Pericleous -- Senior Vice President and Chief Financial Officer

Thank you.  

Operator

Your next question comes from the line of Janet Kloppenburg with JJK Research. Your line is open.

Janet Kloppenburg -- JJK Research Associates -- Analyst

Hi, David. Hi, Perry. Hi, Mark.

David Kornberg -- President and Chief Executive Officer

Hi, Janet.

Janet Kloppenburg -- JJK Research Associates -- Analyst

Hi. I just wanted to ask a few questions about the category performance. I was surprised to hear that the woven top business slowed down in Black Friday, and I wanted to confirm that that had been strong prior to and what you might attribute the slowdown to. Also on the denim front, David, I was just wondering what you think are the factors behind the fact that Express is not participating in the strong denim cycle we seem to be in, and what your outlook is there.

Just lastly, I'm wondering if there's any strategies you can put in place right now to improve the outlook for the fourth quarter. Thanks so much.

David Kornberg -- President and Chief Executive Officer

OK. First point with dressy woven tops, we had a good quarter in dressy woven tops and we've seen it progress throughout the year in terms of our overall performance. All our big key items performed well, the major key items, and we saw growth in Portofino, which was the first time we've seen that in quite a while, so we were very pleased with the overall performance. What we have just seen is we have seen a drop in it and it's really been across the board at the start of the fourth quarter, in the first three weeks essentially.

The second question was about denim, and what I would say is the answer that I gave to the previous question, is we continue to see leggings as being important to our customer. Where we are seeing the strength in terms of new shapes is primarily in dress pants, and we had a very good quarter in dress pants in the third quarter and that was driven by new leg shapes. It was driven by paper bag weights and also wider legs, and we see that continuing as well, so we feel very good about that overall but denim has been a challenge. And then -- but what I would say on the flipside to that is that our strength in wear-to-work is significant and we're seeing that continuing.

So I think that that covers the question. Was there a third one? Oh -- how are we going to improve the overall. I think --

Janet Kloppenburg -- JJK Research Associates -- Analyst

Well, is there anything you can do right now to improve it?

David Kornberg -- President and Chief Executive Officer

Yes, I think what we're doing is we're looking at clearly optimizing our inventory and looking at the areas clearly where we have strength and how we're going to drive our strengths to make a difference as we get into the fourth quarter -- as we go through the fourth quarter. But yes, everybody is absolutely laser focused in terms of making the improvements that need to be made. And as I said, there is still a lot of the fourth quarter ahead of us and what's most important is we have delivered Q1, Q2 and Q3, and there is still, as I said, a lot of the fourth quarter ahead of us.

Janet Kloppenburg -- JJK Research Associates -- Analyst

OK. Thank you and good luck.

David Kornberg -- President and Chief Executive Officer

Thank you. Thanks, Janet.

Operator

[Operator instructions] Your next question comes from the line of Dave Marotta with C.L. King & Associates. Your line is open.

Steve Marotta -- C.L. King & Associates -- Analyst

Steve Marotta, actually. And good morning, David and Perry.

David Kornberg -- President and Chief Executive Officer

Good morning, Steve.

Steve Marotta -- C.L. King & Associates -- Analyst

You mentioned, Perry, that lease relief upon expiration is one of the reasons for levering of buying and occupancy. Can you quantify a little bit what you have seen this year to date in rent relief or leases that have expired and that you've reupped?

Perry Pericleous -- Senior Vice President and Chief Financial Officer

So, Steve, what we've seen is significant improvements in the lease structure as we renew those leases. We get more favorable lease terms in terms of the duration of the lease as well as significant reductions to the previous lease that we had in place. We haven't publicly quantified as to how much this is, but we have been consistently saying that from a B&O standpoint, of course, depending on the mix of e-commerce growth, we can leverage B&O at flat to negative low single digit comps. And you can see that in Q3 with flat comps, we're able to leverage B&O and we do expect to continue to be able to leverage B&O as we move forward, given the rent negotiations.

Steve Marotta -- C.L. King & Associates -- Analyst

Yes, you almost just answered my follow-up, which is do you see anything over the course of the next three to six to 12 months, which would vary from the trend that you have seen, say, year to date?

Perry Pericleous -- Senior Vice President and Chief Financial Officer

We're not seeing anything over the next 12 months that would change the trend that we have seen year to date or even last year.

Steve Marotta -- C.L. King & Associates -- Analyst

Very helpful. Thank you.

Operator

There are no further questions at this time. I would like to turn the call back to David Kornberg.

David Kornberg -- President and Chief Executive Officer

Thank you again for joining us this morning. We wish you a happy and healthy holiday season and new year into 2019.

Operator

[Operator signoff]

Duration: 33 minutes

Call Participants:

Mark Rupe -- Investor Relations

David Kornberg -- President and Chief Executive Officer

Perry Pericleous -- Senior Vice President and Chief Financial Officer

Gabby Carbone -- Deutsche Bank -- Analyst

Susan Anderson -- B. Riley FBR, Inc. -- Analyst

Janet Kloppenburg -- JJK Research Associates -- Analyst

Steve Marotta -- C.L. King & Associates -- Analyst

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