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TMCNet:  EXPRESS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

[June 11, 2014]

EXPRESS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity, and cash flows of the Company as of the dates and for the periods presented below. The following discussion and analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended February 1, 2014 and our unaudited Consolidated Financial Statements and the related notes included in Item 1 of this Quarterly Report. This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors. See "Forward-Looking Statements." Overview Express is a specialty apparel and accessories retailer offering both women's and men's merchandise. We have over 30 years of experience offering a distinct combination of style and quality at an attractive value, targeting women and men between 20 and 30 years old. We offer our customers an assortment of fashionable apparel and accessories to address fashion needs across multiple wearing occasions, including work, casual, jeanswear, and going-out occasions.


The challenging retail environment, which included decreased traffic and heightened promotional activity, continued into the first quarter of 2014.

Comparable sales decreased 11% and both net income and earnings per share decreased 84% compared to the first quarter of 2013. We believe that a portion of this can be attributed to the difficult macro retail environment, but there were also certain product offerings that did not resonate with our customers, particularly in our women's business. We are committed to identifying and fixing these areas and to making progress against our four growth pillars, including improving our sales and gross margins. In addition, we have undertaken a comprehensive review of our operations and expense structure and determined that certain changes can be implemented to reduce costs without materially impacting business operations. We expect savings from these reductions, as well as one-time costs associated with their implementation, to result in approximately $15 million of cost savings in 2014 and approximately $18 million of annual cost savings going forward.

Our first quarter 2014 results and near term plans with respect to our previously mentioned growth pillars are described below.

Improve Productivity of Our Retail Stores For the first quarter of 2014, comparable sales (excluding e-commerce sales) were down 12% compared to the first quarter of 2013. Net sales per average gross square foot decreased from $344 for the twelve months ended May 4, 2013 to $328 for the twelve months ended May 3, 2014. Net sales per average gross square foot is determined by dividing net sales (excluding e-commerce sales, shipping and handling revenue related to e-commerce, gift card breakage, sell-off revenue, and franchise revenue) for the period by average gross square feet in operation during the period. Reversing these declines is a primary focus for us. See "Results of Operations" below for additional information.

Optimization and Strategic Expansion of Our Store Base In the first quarter of 2014, we opened three new Company-operated retail stores, including one flagship store in New York City's Times Square. We opened 17 factory outlet stores in the United States, of which 15 were converted from existing retail locations during the quarter. We recently completed a review of our store base and plan to close approximately 50 stores over the next 36 months, primarily when these stores' leases expire. We expect those closures to result in additional annual operating income of $5 to $8 million beginning in 2015 depending upon the amount of sales that transfer to other stores and e-commerce.

As of May 3, 2014, we operated 628 locations, which included the aforementioned 17 factory outlet stores, compared to 620 locations at May 4, 2013. During the remainder of 2014, we expect to open an additional six retail stores, including one in Canada, and 18 factory outlet stores, including two additional conversions from existing retail locations, in the United States, while closing approximately eight retail stores in the United States.

20 -------------------------------------------------------------------------------- Table of Contents Expand Our e-Commerce Platform In the first quarter of 2014, our e-commerce sales decreased 2% compared to the first quarter of 2013. The decrease in e-commerce sales in the first quarter of 2014 was the result of decreased traffic to our website, which is consistent with the decreased traffic at our retail locations. In addition, we were up against a significant 48% increase in the first quarter of 2013. As we continue in 2014, our focus will remain on improving our overall customer shopping experience with focus on our mobile and tablet discovery and social efforts while optimizing the overall search and checkout process. We plan to accomplish this through improved mobile web shopping optimization , additional capabilities in our mobile app experience and by making significant enhancements to our website with a focus on the shopping cart and checkout. We believe these improvements will make it easier for customers to find and buy the fashion looks and basics they desire. E-commerce sales represented 15% of our total net sales in the first quarter of 2014.

Expand Internationally In the first quarter of 2014, we continued our international expansion by opening one additional franchise store in Latin America, and finalized agreements to bring the Express brand to South Africa through a new franchise partner. At quarter end, we were earning revenue from 26 franchise locations, a net increase of eight stores from the first quarter of 2013. During the balance of 2014, we expect two to five additional franchise store locations to open, including one shop-in-shop location in an Edgars department store in South Africa.

How We Assess the Performance of Our Business In assessing the performance of our business, we consider a variety of performance and financial measures. These key measures include net sales, comparable sales and other individual store performance factors, gross profit, and selling, general, and administrative expenses.

Net Sales. Net sales reflects revenues from the sale of our merchandise, less returns and discounts, as well as shipping and handling revenue related to e-commerce, gift card breakage, sell-off revenue, and revenue earned from our franchise agreements.

Comparable Sales and Other Individual Store Performance Factors. Comparable sales are calculated based upon stores that were open at least thirteen full months as of the end of the reporting period and includes e-commerce sales and store conversions that do not meet any of the criteria for exclusion that follow. A store is not considered a part of the comparable sales base if the square footage of the store changed by more than 20% due to remodel or relocation activities, or if we execute a phased remodel whereby a portion of the store is under construction and, therefore, that portion of the store is not productive selling space. Under the latter scenario, the store is excluded from comparable sales during the construction period only, and is then considered a comparable store when construction is complete. We also review sales per gross square foot, average unit retail price, units per transaction, average dollar sales per transaction, traffic, and conversion, among other things, to evaluate the performance of individual stores and on a company-wide basis.

Gross Profit. Gross profit is equal to net sales minus cost of goods sold, buying and occupancy costs. Gross margin measures gross profit as a percentage of net sales. Cost of goods sold, buying and occupancy costs includes the direct cost of purchased merchandise, inventory shrinkage, inventory adjustments, inbound freight to our distribution center, and outbound freight to our stores.

It also includes merchandising, design, planning and allocation, manufacturing/production costs, occupancy costs related to store operations (such as rent, real estate taxes, landlord charges, common area maintenance, utilities, and depreciation on assets), and all logistics costs associated with our e-commerce business.

Our cost of goods sold, buying and occupancy costs increase in higher volume quarters because the direct cost of purchased merchandise is tied to sales.

Buying and occupancy costs are largely fixed and do not necessarily increase as volume increases. Changes in the mix of our products, such as changes in the proportion of accessories, which are higher margin, may impact our overall cost of goods sold, buying and occupancy costs. We review our inventory levels on an on-going basis in order to identify slow-moving merchandise and generally use markdowns to clear such merchandise. The timing and level of markdowns are driven primarily by seasonality and customer acceptance of our merchandise. We primarily use third-party vendors to dispose of mark-out-of-stock merchandise.

The primary drivers of merchandise costs are raw materials, labor in the countries where our merchandise is sourced, and logistics costs associated with transporting our merchandise.

Selling, General, and Administrative Expenses. Selling, general, and administrative expenses include all operating costs not included in cost of goods sold, buying and occupancy costs, except for certain items which are included in other operating (income) expense, net, such as proceeds received from insurance claims and gain/loss on disposal of assets. These costs include payroll and other expenses related to operations at our corporate home office, store expenses other than occupancy, and marketing expenses, which primarily include production, direct mail programs, media/print advertising costs, digital video marketing, and e-commerce expenses. With the exception of store payroll, certain marketing expenses, and incentive 21 -------------------------------------------------------------------------------- Table of Contents compensation, these expenses generally are fixed and do not vary proportionally with net sales. As a result, selling, general, and administrative expenses as a percentage of net sales is typically higher in lower volume quarters and lower in higher volume quarters.

Results of Operations The First Quarter of 2014 Compared to the First Quarter of 2013 The table below sets forth the various line items in the unaudited Consolidated Statements of Income and Comprehensive Income as a percentage of net sales for the first quarter of 2014 and the first quarter of 2013.

Thirteen Weeks Ended May 3, 2014 May 4, 2013 Net sales 100 % 100 % Cost of goods sold, buying and occupancy costs 70 % 66 % Gross profit 30 % 34 % Selling, general, and administrative expenses 27 % 22 % Other operating (income) expense, net - % - % Operating income 3 % 12 % Interest expense, net 1 % 1 % Other expense, net - % - % Income before income taxes 2 % 11 % Income tax expense 1 % 4 % Net income 1 % 6 % Net Sales Thirteen Weeks Ended May 3, 2014 May 4, 2013 Net sales (in thousands) $ 460,652 $ 509,362 Comparable sales percentage change (11 )% - % Comparable sales percentage change (excluding e-commerce sales) (12 )% (5 )% Gross square footage at end of period (in thousands) 5,456 5,389 Number of: Stores open at beginning of period 632 625 New retail stores 3 3 New outlet stores 17 - Retail stores converted to outlets (15 ) - Closed stores (9 ) (8 ) Stores open at end of period 628 620 Net sales decreased approximately $48.7 million, or 10%, compared to the first quarter of 2013. Comparable sales decreased 11% in the first quarter of 2014 compared to the first quarter of 2013. The decreased comparable sales resulted from decreases in store and e-commerce transactions, and in-store average dollar sales per transaction. We attribute these decreases to a continued decrease in traffic, a heavily promotional retail environment, and not executing up to expectations in either style or depth of our inventory. Non-comparable sales increased $2.4 million, driven by new store openings and remodels.

22 -------------------------------------------------------------------------------- Table of Contents Gross Profit The following table shows cost of goods sold, buying and occupancy costs and gross profit in dollars for the stated periods: Thirteen Weeks Ended May 3, 2014 May 4, 2013 (in thousands) Cost of goods sold, buying and occupancy costs $ 323,279 $ 338,585 Gross profit $ 137,373 $ 170,777 The 370 basis point decrease in gross margin, or gross profit as a percentage of net sales, in the first quarter of 2014 compared to the first quarter of 2013 was comprised of a 340 basis point increase in buying and occupancy costs as a percentage of net sales and a reduced merchandise margin of 30 basis points. The increase in buying and occupancy costs was primarily the result of increased depreciation expense, which was impacted by the opening of the two flagship stores as well as an impairment charge of $0.8 million related to certain underperforming stores. In addition, there was an increase in base payroll and stock compensation expense primarily due to additional headcount at our home office and stock compensation expense related to our annual grant of stock-based compensation.

Selling, General, and Administrative Expenses The following table shows selling, general, and administrative expenses in dollars for the stated periods: Thirteen Weeks Ended May 3, 2014 May 4, 2013 (in thousands) Selling, general, and administrative expenses $ 122,860 $ 112,623 The $10.2 million increase in selling, general, and administrative expenses in the first quarter of 2014 as compared to the first quarter of 2013 was driven by a $7.4 million increase in marketing expense and a $1.5 million increase in payroll. The increase in marketing expense was primarily related to the LED sign at our Times Square store and an increase in digital media spending. The increase in payroll was primarily related to stock compensation expense and additional headcount at our home office to support our growth pillars.

Interest Expense, Net The following table shows interest expense, net in dollars for the stated periods: Thirteen Weeks Ended May 3, 2014 May 4, 2013 (in thousands) Interest expense, net $ 5,897 $ 4,805 The $1.1 million increase in interest expense results from the accounting rules related to our flagship stores in New York and San Francisco. These rules require a portion of the rent payments to be allocated to interest expense. We expect the interest expense related to our flagship stores to be approximately $4.0 to $5.0 million in the aggregate for 2014.

Income Tax Expense The following table shows income tax expense in dollars for the stated periods: Thirteen Weeks Ended May 3, 2014 May 4, 2013 (in thousands) Income tax expense $ 4,036 $ 21,223 23-------------------------------------------------------------------------------- Table of Contents The effective tax rate was 44.3% for the first quarter of 2014 compared to 39.6% for first quarter of 2013. The current quarter effective tax rate was adversely impacted by nondeductible stock based compensation expense and was partially offset by a tax benefit recognized upon the expiration of the statute of limitations applicable to an unrecognized tax benefit.

We anticipate that our effective tax rate will be approximately 40% in 2014.

Liquidity and Capital Resources General Our business relies on cash flows from operations as our primary source of liquidity. We do, however, have access to additional liquidity, if needed, through borrowings under our Revolving Credit Facility. Our primary cash needs are for merchandise inventories, payroll, store rent, capital expenditures, and marketing. The most significant components of our working capital are merchandise inventories, accounts payable, and other accrued expenses. Our liquidity position benefits from the fact that we generally collect cash from sales to customers the same day or, in the case of credit or debit card transactions, within three to five days of the related sale, and have up to 75 days to pay certain merchandise vendors and 45 days to pay the majority of our non-merchandise vendors.

We believe that cash generated from operations and the availability of borrowings under our Revolving Credit Facility will be sufficient to meet working capital requirements, anticipated capital expenditures, and scheduled interest payments for at least the next 12 months.

Cash Flow Analysis A summary of cash provided by or used in operating, investing, and financing activities is shown in the following table: Thirteen Weeks Ended May 3, 2014 May 4, 2013 (in thousands) (Used in) provided by operating activities $ (31,187 ) $ 5,361 Used in investing activities (26,937 ) (16,853 ) Used in financing activities (3,676 ) (717 ) Decrease in cash and cash equivalents (61,676 ) (12,083 ) Cash and cash equivalents at end of period $ 250,208 $ 244,214 Net Cash (Used in) Provided by Operating Activities The majority of our operating cash inflows are derived from sales. Our operating cash outflows generally consist of payments to vendors for merchandise, to employees for wages, salaries, and other employee benefits, and to landlords for rent. Operating cash outflows also include payments for income taxes and interest on long-term debt.

Net cash used in operating activities was $31.2 million for the thirteen weeks ended May 3, 2014 compared to $5.4 million of cash provided by operating activities during the thirteen weeks ended May 4, 2013, a decrease of $36.6 million. The decrease in cash provided by operations primarily related to the following: • Items included in net income provided $28.7 million of cash for the thirteen weeks ended May 3, 2014 compared to $52.7 million for the thirteen weeks ended May 4, 2013. The decrease in the current year was primarily driven by the decreased performance of the business in the first quarter as previously discussed.

• In addition to the decrease in cash provided by items included in net income discussed above, there was $59.9 million of cash used due to working capital changes during the thirteen weeks ended May 3, 2014 compared to $47.4 million of cash used in the thirteen weeks ended May 4, 2013. Working capital is subject to cyclical operating needs, the timing of receivable collections and payable and expense payments, and seasonal fluctuations in our operations. The $12.5 million change primarily relates to increased inventory to support our new outlet stores.

Net Cash Used in Investing Activities Investing activities consist primarily of capital expenditures for new and remodeled store construction and fixtures, information technology, and home office and design studio renovations.

24 -------------------------------------------------------------------------------- Table of Contents Net cash used in investing activities totaled $26.9 million for the thirteen weeks ended May 3, 2014 compared to $16.9 million for the thirteen weeks ended May 4, 2013, a $10.0 million increase from the prior year. The increase primarily relates to investments made in information technology projects to further support our growth pillars.

We expect capital expenditures for the remainder of 2014 to be approximately $83.0 million to $88.0 million, primarily driven by new store construction and investments in information technology. These capital expenditures do not include the impact of landlord allowances, which are expected to be approximately $15.0 to $17.0 million for the remainder of 2014.

Net Cash Used in Financing Activities Net cash used in financing activities totaled $3.7 million for the thirteen weeks ended May 3, 2014 as compared to $0.7 million for the thirteen weeks ended May 4, 2013, an increase of approximately $3.0 million related primarily to stock-based compensation activity. On May 28, 2014, our Board of Directors authorized the repurchase of up to $100 million of our common stock. The repurchase program will be funded using available cash and is expected to be executed during the 18 month period following the authorization.

Credit Facilities The following provides an overview of the current status of our long term debt arrangements. Refer to Note 8 of our unaudited Consolidated Financial Statements for additional information related to our long-term debt arrangements.

Revolving Credit Facility On July 29, 2011, Express Holding and its domestic subsidiaries entered into an amended and restated $200.0 million secured asset-based loan credit agreement.

The amended Revolving Credit Facility is scheduled to expire on July 29, 2016 and allows for up to $30.0 million of swing line advances and up to $45.0 million to be available in the form of letters of credit.

As of May 3, 2014, there were no borrowings outstanding under the Revolving Credit Facility, and we had $198.0 million of availability. We were not subject to the fixed charge coverage ratio covenant in the Revolving Credit Facility at May 3, 2014 because excess availability plus eligible cash collateral exceeded 10% of the borrowing base.

Senior Notes On March 5, 2010, Express, LLC and Express Finance, as co-issuers, issued $250.0 million of 8 3/4% Senior Notes due 2018 at an offering price of 98.6% of the face value. Interest on the Senior Notes is payable on March 1 and September 1 of each year. Unamortized debt issuance costs outstanding related to the Senior Notes as of May 3, 2014 were $4.9 million. We expect to redeem the remainder of the outstanding Senior Notes in the second quarter of 2014 using proceeds from a new term loan facility.

Contractual Obligations Our contractual obligations and other commercial commitments did not change materially between February 1, 2014 and May 3, 2014. For additional information regarding our contractual obligations as of February 1, 2014, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended February 1, 2014.

Seasonality Our business is seasonal and, historically, we have realized a higher portion of our net sales and net income in the third and fourth quarters due primarily to early Fall selling patterns as well as the impact of the holiday season.

Generally, the annual sales split is approximately 45% for the Spring season (first and second quarters) and 55% for the Fall season (third and fourth quarters). Normal cash requirements are typically higher in the first and third quarters due to inventory-related working capital requirements for early Fall and holiday selling periods. Our business is also subject, at certain times, to calendar shifts, which may occur during key selling periods close to holidays such as Easter, Thanksgiving, and Christmas, and regional fluctuations for events such as sales tax holidays.

Critical Accounting Policies Management has determined that our most critical accounting policies are those related to revenue recognition, merchandise inventory valuation, long-lived assets valuation, claims and contingencies, income taxes, and share-based payments. We continue to monitor our accounting policies to ensure proper application of current rules and regulations. There have been no significant changes to the policies discussed in our Annual Report on Form 10-K for the year ended February 1, 2014.

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