“How long can the cash last?”

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That’s the burning question for Francesca’s Holdings (FRAN), a boutique-like retailer attempting to deliver a broad and shallow fashion assortment for women aged 18 to 35 in a treasure hunt experience. Unlike many retailers struggling because of the COVID-19 shutdown, Francesca’s attempts to succeed have been lacking for several years.

Ability to Continue

When the retailer reported its fiscal 2019 fourth-quarter and full-year results on May 1st, it included a warning about its “ability to continue as a going concern.”

As a parting gesture, interim CEO Michael Prendergast had built inventory in the third quarter for the holiday season. The build meant Francesca’s increased its debt obligation to $18.9 million. This was the first third quarter since 2013 where Francesca’s had a debt obligation on its books heading into the holiday season. The funds were borrowed under the retailer’s August 2019 term loan at an interest rate equal to LIBOR+8% relevant to the loan period but at least 10%.

The average revenue per location for the fiscal 2019 holiday quarter was $167,280, a 1.9% improvement from the $164,113 in the fiscal 2018 holiday quarter. The improvement was attributable to a 1% increase in CSS (comparable store sales). Yet, the decision to build inventory was a bust as there was bad news in the details. As it turned out, customer traffic actually declined despite more promotions and deeper markdowns.

The increase in comparable sales was due to higher average units sold per transaction and conversion rates, but was partially offset by a decrease in traffic as well as a decrease in average unit retail prices as a result of deeper markdowns and promotions. (emphasis added)

Newly-appointed CEO Andrew Clarke did not hesitate to call out the blunder in the earnings call.

I believe that this is largely attributed to execution missteps. To summarize the quarter, the primary issue was that we had too much inventory. In addition to softer traffic, the assortment did not consistently align with our customer preferences. (emphasis added)

The quarter and year ended February 1, 2020. Francesca’s started the quarter with $21.2 million in cash and equivalents and $48 million in inventory and ended the quarter with $17.8 million in cash and equivalents and $31.6 million in inventory. SG&A expenses of $42.4 million exceeded the company’s gross profit of $41.2 million. To its credit, the retailer did manage to pay down $10 million of its borrowings.

COVID-19 Warnings

Just weeks later on March 25th, akin to the majority of retailers, Francesca’s found it necessary to shut the doors to its brick-and-mortar locations due to the COVID-19 pandemic. In its annual report, the retailer included a warning regarding its lack of preparedness.

Many of our competitors already have ecommerce businesses that are substantially larger and more developed than ours, which places us at a competitive disadvantage. (emphasis added)

In both 2018 and 2019, e-commerce sales had contributed only 9% of the retailer’s total sales. And, Francesca’s was fully aware of its need for improvement.

We believe that the line between our boutiques and ecommerce channels are disappearing as customers increasingly interact with us both in-boutique and online.

Mr. Clarke reiterated the need in the fourth-quarter earnings call.

I also believe that our ecommerce channel has not been optimized and that this is a key opportunity for us in the future.

We have barely scratched the surface in delivering an exceptional online experience and we know that this is our customer’s preferred way to engage.

The company admitted its online activity was suffering.

While it is not possible at this time to predict with certainty the impact that the COVID-19 pandemic will have on our business, the continued spread of COVID-19 and the measures taken by the U.S. government and the government of the countries in which we operate and in which our vendors and suppliers operate has and/or may continue to result in, among other things, the closure of all of our boutiques from March 25, 2020 to April 30, 2020, when we began reopening a small number of our boutiques in locations where local shutdown orders have been lifted, reduced operating capacity at our ecommerce website and distribution facility, reduced customer visits on our ecommerce website, temporary furloughs of substantially all corporate and boutique employees (for the duration of boutique closures at their location and subject to reduced staffing for a phase-in period upon reopening), base salary reductions for our senior leadership team, suspension of payment of all accounts payable other than those necessary to support our ecommerce business, a shortage of boutique employees who are willing to operate our boutiques when they reopen, a delay in the shipment of merchandise to our boutiques or a shortage of merchandise in our boutiques and a decrease in consumer willingness to visit malls and shopping centers and consumer discretionary spending generally. (emphasis added)

Responding to COVID-19

As did many businesses, Francesca’s took immediate action to attempt to survive the pandemic. The retailer furloughed employees, reduced executive pay and limited capital investments. It also stopped paying most of its suppliers and does not intend to pay its calendar-year second-quarter lease obligations.

The Borrowers have also advised the Administrative Agent that due to conditions relating to the COVID-19 crisis in the United States, the Loan Parties are not paying rent on their leased locations for the months of April, May and June 2020.

At fiscal year-end, Francesca’s had $17.2 million available to borrow under its credit facilities. During its shutdown, the retailer initially borrowed $5 million more. It also applied for a $10.7 million tax refund which must be used to repay “outstanding borrowings.”

The JPM Letter Agreement and Tiger Letter Agreement contain certain conditions and covenants, including that, in the case of the JPM Letter Agreement, we are required to use the entire $10.7 million income tax refund requested under the CARES Act to repay certain outstanding borrowings under the Amended ABL Credit Agreement and providing that no loans will be made under the ABL Credit Agreement unless our aggregate amount of cash and cash equivalents is less than $3.0 million.

Preliminary Fiscal 2020 First-Quarter Results

On June 18th, Francesca’s offered a few preliminary fiscal 2020 first-quarter results for the period ending May 2, 2020. Its cash and equivalents balance had shrunk to $14.3 million while it owed $15 million in borrowings. The $10.7 million tax refund had not yet been received by quarter-end. The retailer reported it had access to $3.1 million under its credit facilities.

Francesca’s did not update on its accounts payable balance. At quarter-beginning, the A/P balance was $10.8 million. It is possible the company may have made payments to suppliers in February. But, with the shutdown, it did suspend those payments. Sales in the quarter totaled $43.8 million. The costs for goods sold and occupancy costs totaled $46.6 million, resulting in a gross loss. Since inventories increased in the quarter from $31.6 million at quarter-beginning to $34.8 million at quarter-end, it is evident the retailer continued to accept shipments of some products though it did state in the fourth-quarter earnings call it was able to cancel a “meaningful portion” of first- and second-quarter receipts. Still, it is quite likely the A/P balance at quarter-end will be greater than $10.8 million.

In its most current annual report, Francesca’s reported lease obligations for fiscal 2020 would be $48.7 million. Since the company announced its intention to forego a quarter’s worth of lease payments, it is logical to assume over $12 million is now past due.

Since the retailer operated at a gross loss in the first quarter, cash flow for the quarter will be negative. Thus, it is clear the existing balance of $14.3 million in cash plus the upcoming refund of $10.7 million plus the $3.1 million in additional credit is not sufficient to cover the current debt obligation of $15 million plus the accounts payable balance of $10.8+ million plus the $12 million in delayed lease obligations as well as current lease obligations.

As the quarter ended, the retailer began re-opening brick-and-mortar locations and, as of June 12th, had managed to open nearly 85% or 593 of its 703 locations. Francesca’s reported its cash balance on June 12th had increased to $21 million. It also reported it had no remaining borrowing availability. Thus, of the $6.7 million in additional cash, it could be assumed the company borrowed the remaining $3.1 million. Unfortunately, Francesca’s neglected to mention that it had made any progress toward paying down its debt and stated again it was deferring supplier and lease obligations. Thus, the additional $3.6 million generated in cash for almost six weeks from May 3rd through June 12th must be considered earmarked for those obligations as well as increased SG&A expenses such as payroll associated with reopening its doors.

Progress Before Coronavirus

Francesca’s noted in its preliminary results it had used aggressive markdowns to help generate its $43.8 million in sales for the quarter. As well, it could be assumed the majority of those sales were obtained during the 7+ weeks brick-and-mortar locations were open from February 2nd through March 25th. In the fourth-quarter earnings call, the retailer mentioned “positive comps in February.”

In the fiscal 2019 first quarter, Francesca’s had reported e-commerce sales “underperformed expectations.” Total sales tallied $87.1 million. Since the retailer had averaged e-commerce contribution of 9% the previous year, it could be assumed e-commerce sales for the quarter were less than $8 million. Thus, in-store sales likely topped $79 million for an average of $8,447 per store per week.

Had Francesca’s achieved the same performance level for the 7+ weeks doors were open during the fiscal 2020 first quarter, it would have generated over $44 million in in-store sales. Since the total inclusive of e-commerce activity was only $43.8 million, it is not a stretch to surmise the retailer’s performance suffered even before the pandemic forced doors to shutter. In the fourth quarter earnings call on May 1st, the retailer did note “e-commerce sales were up 25% quarter-to-date.”

A 25% improvement on less than $8 million would not top $10 million. Thus, e-commerce sales may have contributed approximately 22% of the quarter’s total which means in-store sales would have likely tallied less than $34 million. The tally equates to an average per store per week of only $6,534, a 20+% decline year-over-year. If e-commerce sales managed to contribute more than 22% of the quarter’s total, the year-over-year comparison of in-store sales only worsens.

Progress Since Coronavirus Remains Questionable

In its fourth-quarter earnings call, Francesca’s reported an increase in website traffic since the onset of the pandemic shutdown. The retailer reported 20% of its visitors were first-timers. Specifically, it identified interest from consumers aged 18 to 24 years old. Mr. Clarke noted he was “excited to see this.” Yet, it should not be ignored that just a few years ago, CEO Steve Lawrence specifically blamed a focus on the younger demographic for some of Francesca’s failures.

We have been too focused on the younger end of our customer spectrum.

In the past, many of our fits and stylings are too young or junior, while other styles were targeted at older demographics who required a different fit. Going forward, we will have much better consistency in our offering with the team focusing on providing apparel that will appeal to women in her mid-20s and early 30s.

Since the pandemic, Francesca’s also noted visitors spending “more time on the site” and navigating “deeper into the site than ever before.” Under normal circumstances, this might be worthy of celebration. However, it cannot be ignored these same shut-in visitors were confined to activities at home when compared to “before.” More available time with less distraction could easily lead to such results.

As well, it should not be ignored Francesca’s admitted it had offered a 50% discount to its entire inventory in the period from Thanksgiving through Christmas and still ended up with surplus inventory at fiscal year-end. It continued clearance promotions into the first quarter. While this level of discounting and promotion attracts attention, it would not be conducive to driving profitability.

The retailer also reported on May 1st its average online spend from mid-March had increased 12% compared to being “flat year-over-year prior to the outbreak.” While this appears as progress, it should not be ignored the online spend was flat prior to the outbreak despite deep discounting. It should also not be ignored the company’s “primary focus” on May 1st continued to be “driving down inventory levels.” And, since fiscal year-end, inventory levels have only increased.

Mentioned already, like other retailers, Francesca’s was concerned shoppers’ hesitancy to visit brick-and-mortar locations and to spend on discretionary items may be long-lived. If this were to prove true, the retailer’s near-term performance post-pandemic could be even worse than before the pandemic. Initially, it reported results were “better than expected” as physical doors re-opened though the retailer did not quantify initial expectations. Discounts are still deep and promotions still high which has aided conversion. Yet, traffic is negative. As well, Francesca’s has already noticed a deceleration in e-commerce activity with retail locations re-opening.

In the preliminary results call, Mr. Clarke noted what some could consider several points of “progress.” He mentioned the retailer had “reduced the layers in the teams to speed up decision-making.” It is quizzical interim CEO Prendergast claimed he did the same.

Our first priority in fiscal 2019 is to transition the merchandising process to enable the successful execution of a demand based, fast fashion business model.

The cost structure of the organization outpaced the sales levels and was saddled with added layers within various business functions.

The strides we have made in building a foundation to execute a fast fashion model through a flatter and more nimble organization led to an inflection point in our comparable sales. (emphasis added)

Mr. Clarke also intends to “reduce the mix of commodity basics in our assortment leaning towards more fashion pieces while reducing SKU count overall.”

Those “commodity basics” were intentionally added in 2016 after the retailer cited customer disappointment in the lack of availability.

We are ensuring that these items are in stock across locations – that we have the proper flow and optimal representation in all channels of distribution. The most-loved items will also be balanced with our offering of trend-right fashion product. (emphasis added)

As for the need to reduce the SKU count, Mr. Prendergast had, supposedly, found otherwise.

In addition, based on our inventory planning and analysis, we determined that we have operated with less than optimal inventory levels in recent years. (emphasis added)

Finally, Mr. Clarke mentioned an intent to address the retailer’s vendor relationships by “aligning more closely with fewer vendors” in hopes of gaining “cost efficiencies with fewer partners.”

The decision pendulum on vendor count has also swung widely over the years. From 2010 to 2012, the retailer’s top ten vendors supplied 45%, 42% and 46% of its merchandise, respectively. Of the top ten, Francesca’s relied more heavily on two vendors, KJK Trading and Stony Leather, both considered related parties.

Since its IPO in 2011, Francesca’s has typically claimed to have a vendor base of 400 to 500. Consistently, on an annual basis, it has reported 90+% of its merchandise being sourced from 200 vendors. In fiscal 2019, approximately 97% was sourced from 200 vendors while the top ten vendors accounted for approximately 35%.

Narrowing its vendor count is hardly a novel concept for the retailer. In the fiscal 2016 third quarter, Francesca’s attributed some of its shortfall to implementation of the same idea.

Third, as we gradually narrowed our vendor base over the last few years, we shifted too many receipts to vendors who service big box retailers and away from our traditional West Coast supplier base. While we continue to add our Francesca’s touch to the product, some of the current assortment was too similar to items being sold by other retailers. We believe this has made our assortments less special eroding some of the uniqueness of our offering, which in turn has made us more susceptible to competition on pricing. (emphasis added)

And, then there was the subject not addressed in the preliminary results that probably should have been – status on the retailer’s intentions for dealing with under-performing locations. In the fiscal 2019 first quarter, Francesca’s closed 8 locations. A year later, it again closed only 8 locations even though it incurred non-cash impairment charges in the fiscal 2019 fourth quarter on 53 under-performing boutiques. Of even more concern, Francesca’s continues to have a long-term focus on location growth as noted in its annual report.

While we are currently focused on optimizing our existing real estate fleet, we believe we will have an opportunity to grow our boutique base in the United States and that our long-term strategy depends upon our ability to successfully open new boutiques. (emphasis added)

Takeaway

Considering Francesca’s paid at least $1.5 million in consulting fees for an interim CEO in fiscal 2019 backed, purportedly, by an entire organization specializing in retail performance improvement, one has to question why newly-appointed CEO Andrew Clarke even has a plateful of issues to resolve. In that regard, one has to wonder if the issues are even resolvable.

Perhaps it’s simply unreasonable to expect any one person to have all the answers to all of Francesca’s problems. Sure, it could be possible Mr. Clarke has all the answers and he’s simply, generously, sharing his expertise with a struggling retailer. Then again, if the retailer’s issues are actually not resolvable, his expertise may prove a moot point. What seems without question, so far, is that he has not identified a single issue unique from the problems the last six men in his position over the last eight years have tried to address. Neither do his solutions seem so unique. In my opinion, it is discomforting to hear solutions proposed which are known to have created problems in the past.

And, then there are the issues created by the pandemic. The return of customer foot traffic, much less a growth in such, is still questionable and even more so due to the coronavirus pandemic. Yet, by the retailer’s own admission, even if the demand transferred online, its capabilities and capacity would be inadequate were it to encounter exponential growth.

Regardless, whether these past and new issues are resolvable or not, the retailer now faces a ticking clock bound to its purse strings. Francesca’s can only sell merchandise under cost for so long. The tax refund is obligated toward debt repayment which could, in turn, free up some borrowing capacity. Yet, the company’s expenses should naturally inflate as it covers payroll and stocks merchandise for the changing seasons (and that’s assuming its unpaid vendors are willing to continue to supply it). With its current credit availability exhausted, bills continue to mount and its cash is inadequate to pay both past-due and coming-due obligations. It is probably unreasonable to count on vendors and landlords waiting indefinitely.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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