FRANCESCA’S HOLDINGS, INC. (FRAN) – INITIAL WRITEUP – RISKS, OF COURSE, BUT HUGE UPSIDE POSSIBILITIES!
Francesca’s Holdings, Inc. (FRAN) is a Company I have followed for many years. It was considered, just a few years ago, as a differentiated young women’s apparel retailer with strong store level economics, well positioned strategically to provide a unique shopping experience. As described below, and as shown in the table above, FRAN has gone through about three dismal years. The operating results, prior to the pandemic, drove away most investors. Interim management stabilized the situation in 2019 and the pandemic hit just as new, highly qualified, management was installed. In the wake of investor disillusionment with “anything retail”, FRAN stock has declined to the point that virtually no possibility of fundamental recovery is implied. There are, to be sure, many unanswered questions, as described below. However, we are impressed with the credentials and the initial efforts of new CEO, Andrew Clarke. If Francesca’s can return to even half of its previous peak earnings power of $13.18/share, FRAN could trade at 10-20x its current value. Longer term, if CEO Clarke’s turnaround and omni-channel expertise combines well with Francesca’s nationwide physical presence, the upside could be even more impressive.
Houston based Francesca’s Holdings, Inc. operates a nationwide chain of just over 700 apparel boutiques, averaging about 1450 square feet in size, selling modestly priced, fashion driven merchandise (apparel- 46% of sales, jewelry-27% , accessories-16% and gifts-10%) to a core market of women, aged 18 to 35. The Company had a solid history of success from the time it went public in 2011 until calendar 2016, growing its number of stores, building same store sales to a peak of $545/square foot with high margins, generating a high return on invested capital, managing a strong balance sheet, with the stock often selling at 20-30x expected earnings and 12 to 18x trailing twelve month EBITDA. The personalized approach at the store level, selling a curated selection of modestly priced, fashion following (rather than leading) merchandise allowed FRAN to compete successfully with much larger (both brick and mortar and on-line) companies and presumably ensured a strategically well positioned future. It is noteworthy that Francesca’s on-line presence has not, until very recently, been more than 10% of sales, so that remains an important opportunity.
All of this went awry several years ago when new management, with “big box”credentials, allowed the Company to become slower to react, over-inventoried in the wrong items, less fashion sensitive, in effect straying from the “read and react, fashion following” strategy that had been the core of Francesca’s success. In late calendar 2018, Alvarez and Marcal (a well regarded retail turnaround consulting firm) was retained to study and then manage the business. A&M’s agent, Michael Prendergast, was installed as interim CEO early in 2019 and stabilized the business during 2019, as shown in the statistical table above. In February, 2020, a permanent CEO, Andrew Clarke, was recruited. He is experienced with turnaround situations, has negotiated with vendors and suppliers In the course of flowing new product while managing working capital. His experience with women’s “fast fashion”, successfully applying omni-channel distribution and marketing, is especially applicable to Francesca’s. Time will tell, of course, but the Board’s choice of Andrew Clarke seems well considered.
Sales and earnings peaked in calendar 2016, the fiscal year ending 1/31/2017. We interject here that there was a one for twelve reverse split in mid-2019, so the reported peak earnings shown in the table above of $13.18 per share were reported at the time to be $1.10. Accordingly, the stock peaked in late 2016 at about $250 per share based on the current capitalization. The all time peak of over $400/share was in 2012. The result today is that the stock, now under $5.00/sh., down from an all time high of $400 and with only three million shares outstanding, provides a total equity value under $15M for a company that just last year, was still doing over $400 million (with a GAAP loss but still positive Adjusted EBITDA. It is also crucially important that, even today, as the pandemic (hopefully) winds down,, the Company has no net debt. The challenge, of course, is to manage the balance sheet as stores are reopened, inventory is refreshed and seasonal needs are met, but at least the Company is not in a hole as the process begins.
The statistics in the table above show historical peak earnings of $13.16 per share, FRAN still doing close to $400M of annual sales, no current net debt, an enterprise value today at 1.4x trailing twelve month depressed Adjusted EBITDA, and an Enterprise Value under $15M. As you might expect, there are more than a few risks to be considered, including:
Almost half (342 at 2/1/20, of which 91 are in outlet centers) of the 700 boutiques are located in shopping malls, obviously not the best place to be in a post-pandemic world. The fashion driven sales per square foot have declined to $390/ft. in the latest fiscal year, and it was more promotionally driven than hoped. New management, led by Andrew Clarke, has just recently been installed. Though the credentials are impressive, the results are yet to come. The latest balance sheet, as stores reopen, discussed below, could prove to be inadequate to support the operating plan. More debt could be expensive and equity issuance could be very dilutive to existing investors. Negotiations continue with landlords and future traffic in malls is uncertain. Vendors have apparently worked constructively with the new management team as post-pandemic plans are implemented but this might not be the case for long, depending on results. Relative to FRAN stock, there is no current apparent coverage, and the small capitalization could discourage future institutional investors. There is a 22% equity owner, Cross River Management, who could potentially sell their stock. Alternatively, Cross River could increase their position, even to the point of buying the entire Company, perhaps to the detriment of other public shareholders.
On the other hand:
The potential of FRAN must be based on store level economics, potentially enhanced by materially higher online sales. Peak sales of $545/ft. (under 10% of which were on-line) declined to $390/ft. most recently. The objective of the new management team is obviously a recovery in AUVs, with a much broader omni-channel approach. The relatively small footprint of 1,462 square feet provides a personalized boutique shopping experience and is unique relative to competitive apparel retailers. From the landlord standpoint, FRAN remains attractive as a tenant, as capable as any to pay a fair rent. The physical presence of 700 locations can prove to be a unique asset for the Company, even as the omni-channel approach is pursued. The opportunity for a customer to see and feel the product before purchase, and return or exchange in a nearby location can help FRAN differentiate their commodity.
The balance sheet seems adequate, for the moment at least, discussed further below under “Recent Developments”. There appears to be the possibility of raising debt capital on attractive terms under the pending US government Main Street Lending program. Should that prove to be the case, there would be less need for more expensive debt or dilutive equity capital.
Our observation from personally visiting dozens of locations over the last year is that the store level sales culture is one of the most important long term assets. The stores have almost invariably been staffed by sales personnel that are age appropriate, knowledgeable and enthusiastic about their,product, prepared to be helpful without being intrusive in the sales process. We had many conversations with store level personnel who had been with FRAN for several years at least, who reflected on the improvements in merchandise and the fact that “corporate is listening to us again”. Very successful retail companies, such as Lululemon, Ulta Beauty, and Starbucks have successfully weathered difficult periods, with their store level operating culture providing the foundation of the effort. While it is obviously “a reach” to compare FRAN to these much larger very successful companies, if Francesca’s turns the corner, the store level culture, which doesn’t happen by accident, will have been a critical necessary ingredient.
POSITIVE ADJUSTED EBITDA, IN THE WORST OF TIMES
There has been a positive Cash Flow from Operations and Adjusted EBITDA even in the last two disastrous years.
In the year ending 2/2/2019, Net Cash from Operating Activities was $9.5M. Aside from working capital changes, the largest non-cash addbacks to the $40.9M GAAP loss were $24.5M of D&A and $20.1M of Asset Impairment charges. Adding back the D&A, Asset Impairment, Interest of $426K and $7.5M of taxes would have provided Adjusted EBITDA of $11.6M.
In the most recent year, ending 2/1/2020, Net Cash from Operating Activities was $2.8M. Aside from working capital changes, the largest non-cash addbacks to the $25.0M GAAP loss were $21.4M of D&A and $11.9M of Asset Impairment charges. Adding back the D&A, Asset Impairment, Interest of $1.2M and $125k of taxes would have provided Adjusted EBITDA of $9.6M.
THE BALANCE SHEET – Year End, 2/1/20, and 5/2/20 (Q1’20)
Cash at 2/1/2020 was $17.8M, down from $20.1M a year earlier. A/R had been reduced by $13M, Inventories were up by $1.2M, Prepaid Expenses were up $2.0M, A/P was down by $13.5M, Current Portion of LT Debt was $8.9M vs. 0, Long Term Debt was zero, down from $10M.
Total cash and cash equivalents at the end of the first quarter were $14.3 million compared to $17.5 million at the end of the comparable prior year period. As of May 2, 2020, the Company had a $15.0 million of combined outstanding borrowings and a combined borrowing base availability of $3.1 million under its Amended ABL Credit Facility and Term Loan Credit Agreement.
SUMMARY Q1’20 (5/2/20) OPERATING RESULTS – Per the 8-K filing on 6/18/20:
“As the Company’s boutiques began to reopen, its cash position increased to approximately $21.0 million as of June 12, 2020 from $14.3 million as of May 2, 2020 (the end of Q1). This increase was primarily due to the Company’s efforts to drive sales and monetize existing inventory, aggressively reducing costs and managing cash flows, including deferring payments for rent, inventory and other accounts payable, subject to discussions with landlords and vendors. Additionally, the Company also expects to receive an income tax refund of $10.7 million related to certain provisions under the Corona Aid, Relief and Economic Security Act during the second quarter of fiscal year 2020. This refund is required to be used to repay the approximately $5.0 million in outstanding borrowings under the ABL Credit Agreement as of May 2, 2020 along with any other then outstanding borrowings under the ABL Credit Agreement in accordance with the letter agreement entered into between the Company and the ABL Credit Agreement lenders. As of June 12, 2020, the Company had no borrowing base availability under its ABL Credit Agreement.
“Net sales decreased 50% to $43.8 million from $87.1 million in the comparable prior year quarter primarily due to the mandated boutique closures beginning on March 25, 2020 and continuing through the end of the first quarter related to the COVID-19 pandemic. This decrease was partially offset by strong performance in ecommerce as all of the Company’s efforts subsequent to March 25, 2020 were focused on driving ecommerce sales during the temporary boutique closure period. The Company permanently closed eight boutiques during the first quarter, bringing the total boutique count to 703 at the end of the quarter.
“Gross loss, as a percent of sales, was (6.6%) as compared to gross profit, as a percentage of sales, of 34.8% in the prior year quarter. This unfavorable variance was primarily due to lower deleverage in occupancy costs as a result of lower sales. Occupancy costs include the full lease expense for all boutiques for the month of April 2020 (editor Note – which was not paid, presumably deferred and/or abated). Additionally, merchandise margin decreased due to aggressive markdowns and promotions as well as increased higher inventory reserves due to the COVID-19 pandemic.
“Selling, general and administrative (SG&A) expenses decreased $15.0 million or 38% to $25.0 million from $40.0 million in the prior year quarter. Adjusted SG&A in the first quarter of fiscal 2019 was $38.0 million and excludes $1.2 million of consulting expenses associated with the Company’s review of strategic and financial alternatives and turnaround strategy, $1.1 million in severance benefits and other payroll costs also associated with the turnaround plan, and $0.3 million of stock-based compensation reversal associated with the departure of certain employees. There were no non-GAAP adjustments to SG&A in the first quarter of fiscal 2020.
“The $13.0 million decrease in adjusted SG&A versus the comparable prior year period was primarily due to a $10.7 million decrease in boutique and corporate payroll costs as a result of the temporary furlough of substantially all of the Company’s employees, a $0.9 million decrease in boutique and corporate bonus expenses and $0.6 million decrease in professional fees.
“The Company ended the quarter with $34.8 million of inventory on hand compared to $32.2 million at the end of the comparable prior year period. Average inventory per boutique increased 11% at May 2, 2020 compared to May 4, 2019 due to the mandated boutique closures as a result of the COVID-19 pandemic. (Editor Note – Inventory management on a quarter to quarter basis has been less than ideal in the last several years, presumably providing opportunity for improvement under new management.)
RECENT DEVELOPMENTS – as boutiques reopen
Per the 6/18/20 earnings release and conference call: The operating loss for Q1, as provided above, was obviously due to the required closing of the entire chain. At the same time, Andrew Clarke, CEO since 3/9/20, made clear his optimism for a successful long term recovery and new growth for the Francesca’s Holdings brand. 85% of the stores are now reopened, the balance to operate by the end of July. Q2 will be a process of liquidating store level inventory to make room for new product. Online sales were up 85% during the Pandemic. While that gain has moderated as stores have reopened, a far larger omni-channel presence for Francesca’s is a long term opportunity. Stores that have reopened have shown encouraging sales. As stated on the call: “On average, retail sales are running at similar levels to the same prior year period. The significant increase in conversion and average units per transaction indicating acceptance of promotional and engagement strategies and have offset negative traffic trends.” Purchasing is through fewer vendors, and relationships are apparently improved. Better inventory management is a particular opportunity and a number of new hires, including a new SVP of Merchandising, have been made. Rent was not paid in April, May and June and negotiations have resulted in reductions and/or deferrals into calendar ’21 and beyond. The existing fleet of about 700 locations is expected to be largely maintained.
CONCLUSION – Provided at the beginning of this article