Q2 2019 Earnings Call
Greetings and welcome to the tailored brands. The Q2 2019 results conference call. At this time all participants are in a listen only mode. A question answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad. Please note. This conference is being recorded I would now turn the comfort separate your host Julie Macmedan, Vice President Investor Relations.
Let's make me then you may begin.
Thank you and good afternoon, everyone welcome to tailored brands second quarter 2019 results Conference call. This call is being webcast and a replay will be available on the company's investor Relations website.
IR Dot killer grants dot com.
Please note that comments made during the conference call contains forward looking statements within the meaning of the United States Federal Securities laws.
These statements are subject to significant business economic.
And competitive risks uncertainties and contingencies.
Many of which are beyond our control.
Any forward looking statements are not guarantees of future performance and actual results may differ materially from those in such forward looking statements.
Please refer to today's earnings release, our annual report on Form 10-K , and quarterly reports on forms 10-Q to understand these risks and uncertainties.
You can access all these reports on the Telegraph <unk> IR website.
In addition, the information on this call speaks only as of today September 11, 2019, and we assume no obligation to publicly update or revise our forward looking statements.
Throughout this conference call management will be discussing results on an adjusted basis.
A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful.
Our discussed in todays earnings release.
With me today are president and CEO , Dinesh Latinos and our CFO , Jack Calandra I would now like to turn the call over to Dinesh.
Thank you Julie and good afternoon, everyone earlier today, we released our results for the second quarter of 2019, and I'm pleased to report that our earnings per share of 82 cents exceeded the high end of the guidance range. We provided in June of 65 cents to 77.
As Jack will describe in greater detail our outperformance on the bottom line was the result of topline sales that were in line with guidance, coupled with expense favorability, primarily and lower marketing spend and lower incentive compensation costs.
Well delivering at or above guidance on the top and bottom line is important and reflects the substantial in collective effort of our nearly 20000 colleagues.
No wonder tailored brands will be satisfied until we have transformed our customer facing experience to one that can generate sustainable bottom and top line growth.
Back in March I indicated that we had work ahead of us to transform our customer facing experience and that the transformation would take time.
Our Q2 comps and our outlook for Q3 reflect the fact that.
We are in the midst of a transformation.
That transformations take time.
And that we are executing our transformation in a challenging retail environment.
Despite these challenges we are confident and excited about our business because of the way the customer is responding to our initiatives.
To that end before turning it over Jack who will cover the financials in more detail.
I want to update you on our progress on transforming the customer experience.
Roughly six months ago, we identified three areas that we believe we're going to be critical to transforming the customer experience they are personalized products and services.
Inspiring and seamless experiences and then across every channel.
And brands that stand for something more than just price.
[laughter] personalized products and services are a priority because the customer is not only demanding personalization and his online experiences, but is increasingly demanding it off line as well.
And our transformation journey the early stages of delivering personalization have been focused around two things.
The first is custom clothing and the second is merchandising that better reflects how he dresses for work and special occasions today.
Our custom business continues to grow at a healthy double digit rate a multi hundred million dollar scale.
In Q2, we averaged over 6 million a week in custom suiting up from over 4 million a week in Q2 of 2018.
We are leaning into the positive response to cost them by continuing to push innovation in this category.
In July we introduced the opportunity for customers to choose from a set of fun non traditional linings, featuring icons florals and tropical patterns for their custom garments.
We've seen a strong response since the launch of the program and the good news is is that these digitally printed linings have a short lead time, allowing us to test into new designs without needing to acquire significant inventory upfront.
The positive customer response to statement linings, let us to consider other jacket mining innovations and last week, we announced that we had entered into a multi year licensing agreement with the National Football League.
This agreement enables us to offer sports fans the ability to customize their seats and sport coats, what lining depicting most of their favorite NFL teams.
We're very excited to continue to develop this NFL offering that's part of our goal to deliver the ultimate personalized experience for our customers.
We are also working to intubate the process of buying a custom garment last quarter. We shared with you that we were in beta on custom builder.
A tablet based app designed to assist our wardrobe consultants and customers with the in store customer buying experience.
Since then we have rolled out the app across our entire men's wearhouse suite and the majority of our Joseph Bank fleet.
Feedback from our wardrobe consultants has been incredibly positive and we are already seeing an improved customer experience and gains in consultant efficiency due to a more engaging and quicker sales process.
For example.
Stored customer profiles and new features allow consultants to seamlessly duplicate a customer specific measurements and choices in a second or third fabric for a multiple unit purchase saving substantial time for both the costs consultant and the customer.
Later this month, we will launch custom builder the balance of Jos a bank stores and across all more stores in Canada.
In addition to custom clothing, we've also talked about the opportunity to present, the customer and assortment, which better reflects the way. He is dressing today for work and special occasions.
Despite challenging traffic trends in our polished casual categories. We saw sequential improvement at men's Wearhouse, and we were pleased with the performance of sportswear and dress shirts at Jos a bank.
Polished casual strength was driven in part by new product introductions, such as dinner jacket.
Seasonal red and overseen sport coats.
Short sleeve and fall transitional long sleeved sports starts.
And shoes led by new more casual uncomfortable style.
The one exception what sport coats, the Jos a bank, which was so popular that unfortunately, we could not keep up with demand.
The good news is that we have our new fall sport coats in stores as well as new alternative complete or pieces for a business casual outfit includes.
Card again and that sweaters.
Mitt bomber and trucker jackets, and less structured sport coats.
The second strategic initiative, we discussed was creating inspiring and seamless omni channel experiences.
On our store experience, we're making progress on several fronts.
Last quarter, we shared that we were running tests to measure the impact of enhanced fixtures in store graphics and product presentation.
The results came in during Q2, and we learned which types of stores respond at highlighting each aspect of the investment.
We are in the process of rolling out those elements of the design to the stores in the fleet that matched the winning profile.
We've also been experimenting with labor in our stores. We believe that helping then look and feel that are best for the moments that matter requires a personal touch.
So we experimented with additional labor on the weekends.
That experiment was a winner.
We saw a meaningful lift in sales with the test stores that more than paid for the additional labor and we are in the process of scaling this new labor model more broadly.
On the E Commerce front, we continue to be pleased with the pace at which our E. Commerce teams are improving the online experience for our customers.
Our e-commerce sales penetration is much lower than our retail peers and I am really excited about the potential to close this gap.
Over the past six months, we have focused on elevating our ecommerce experience to achieve our goal of delivering and inspiring and seamless omni channel experience.
We believe that successful execution of this strategy presents a large unlocked for our business on both the top and bottom line.
Last quarter, we talked about how we had implemented agile software development methods to dramatically increase the number of tests we're running.
Whereas Q1 was very much about implementing these new working methods Q2 was where we started to see dramatic business impact.
The change in trajectory of our ecommerce business since the beginning of the summer has been fantastic and is due in part to both the growth in traffic associated with our increased investment in digital marketing.
And a robust test roadmap that has yielded substantial conversion rate enhancements versus the control experience.
An example of one of the features that we have scale based on test result.
Serving customers with weather based product recommendations.
Based on what we can discern about a customer's location they will see a message about the top navigation customized to the weather and their location such as trust for 62 degrees shop now.
Once they click on that message, we take them directly to weather appropriate products like a quarters that pulled over.
We are also focused on streamlining the design on both mobile and desktop to gift products and call to action more prominence.
This means adjusting navigation product imagery spacing and font size is to help the shopper quickly find what they are looking for.
Getting customers to products faster, it's driving higher conversion.
[noise] E Com is an area, where we continue to be really excited about and the results. We are seeing our strong confirmation that we are starting to deliver what our customer wants.
The third strategic initiative, we discussed was evolving our brands stand for something more than just price.
The focus of this initiative is twofold first to engage our customers in the media channels. They frequently.
And second to tell the stories of our brand set of customers better understand what they're getting for their dollar.
On the channel shift we've made significant progress our marketing spend in digital channels is up 31% compared to Q2 of last year.
Based on the foundational work and testing we conducted through Q1, we are confident in our ability to put dollars to work in digital channels, a greater efficiency than we are achieving in broadcast channels.
We are pleased to report, thereby increasing our digital marketing efforts, we have seen increases in purchase intent for Seaton business casual at both brands, particularly among millennials and we plan to step up our digital spend in Q3 relative to Q2.
Last quarter, we also talked about the launch of new advertising campaigns about men's wearhouse ingest a bank.
And were pleased to see that these campaigns, which had a brand storytelling orientation are resonating more with the important millennial segment when compared to more price promotion oriented spots.
We've been leveraging the new brand campaign content through numerous channels such as broadcast digital our E com sites.
And our Joseph a bank fall catalogue.
Looking ahead, our goal is to focus in on specific stories, we know our customers care about and amplify that in across all marketing touch points.
We are also looking forward to leveraging the strong brand recognition that the national Football League brings to us through our new licensing agreement.
Finally in addition to the progress we've made on our customer facing initiatives. We've also made some significant new additions to our senior ranks at the men's wearhouse memoirs.
These leaders were universally attracted to the opportunity and the challenges of transforming our customer experience.
And each of them brings a track record of delivering impact and outcomes and their respective domains.
Maryann Mcgrath joins us as SVP and Chief marketing Officer from Williams, Sonoma, Inc., where she led the transformation of multiple brands to a digitally focused data driven marketing approach and drove significant sales and customer growth.
Jerry brand Hawk joins us as SVP and general merchandise manager from PVH Corporation, where he led the North American Calvin Klein jeans, and sportswear business after a distinguished career in merchandising at leading specialty retailers.
And finally, Jarmila Souter car comes onboard as VP of E Commerce from Walmart Dot Coms home decor business, where she drove meaningful topline growth and profitability for the home Division.
We are delighted to have them on board and we are already benefiting from their new perspectives and ideas.
Their execution orientation and their customer obsession.
With that context of progress on our customer facing strategic initiatives.
I'll now turn the call over to Jack.
In addition to discussing the financials for the quarter in more detail will also cover our updated capital allocation framework.
Our cost savings initiatives.
And our guidance for Q3 2019.
Thanks to Nash and good afternoon, everyone. Today I'll review, our updated capital allocation strategy the expected impact of recently enacted tariffs.
Second quarter financial results and guidance for the third quarter.
I will also share with you the progress, we're making on our multiyear cost savings and operational excellence programs.
I'd like to start with the recently completed sale of corporate apparel and the updated capital allocation strategy, we announced in today's release.
We were pleased to sell the corporate apparel business on August 16th in order to focus on core retail operations in the U.S. in Canada.
And strengthen the balance sheet.
The sale also improves both our pro forma leverage ratio and operating margin.
We expect to present the sale as a discontinued operation beginning in the third quarter.
Of the 62 million cell price, we have received approximately 50 million in cash after working capital adjustments and will receive an additional 6 million in the first quarter of fiscal 2020.
We are reinvesting these proceeds in the business and this frees up funds previously slated for capital expenditures to pay down debt.
In addition, today, we announced the suspension of the 18 cents per share quarterly cash dividend starting in Q4.
On an annual basis. This will make available about 36 million to be used for a combination of share buybacks and accelerated debt reduction.
This change does not impact the previously approved 18 cents quarterly cash dividend payable on September 27th.
I want to take a moment to explain why we are making this change.
Simply put we strongly believe given the current stock price and dividend yield that there is a more efficient way to allocate capital and that redeploying cash from the dividend into a combination of share buybacks and debt reduction will enhance long term value creation for all stakeholders.
For executing share buybacks, we have 48 million available under an existing repurchase authorization from our board.
I also want to reiterate our unwavering commitment to paying down debt and strengthening the balance sheet.
Over the past two and a half years, we've made significant progress on debt reduction, reducing total debt by over 440 million with a focus on the 7% senior notes that mature in July 2022.
We also extended the maturity on our largest tranche of debt the 884 million dollar term loan to 2025.
Although our debt to EBITDA ratio has increased this year due to business performance, we remain committed to reducing debt to EBITDA to three times over the medium term.
Now I'd like to provide our current assessment of how tariffs on imports from China impact the business.
As a reminder, the first three less of tariffs largely do not impact the goods, we source and any financial impact from those tariffs is immaterial.
The fourth list to which a 15% tariff is being applied is comprised of two groupings. The first of which went into effect September 1st and the remainder of which goes into effect December 15th.
Most of our product falls into that first grouping.
This has been a somewhat fluid process, but we believe we can absorb the list for tariffs within the existing product cost structure with minimal impact to the bottom line this year.
This is due to both diversifying our sourcing and working with our vendor partners in China to help mitigate the impact of the tariffs.
We had already reduced the percent of direct source product from China from approximately 30% in 2017% to 23% last year.
For 2019, we expect to lower that further to between 18% and 20%.
Turning now to the second quarter results I'd like to make sure everyone knows that I will be discussing adjusted numbers today, which eliminates certain items that are not indicative of core business results.
Please refer to our press release for more details.
Total sales for the second quarter were 789 million down 4.1%.
Retail sales were down 4.1% with comp sales down 3.6%.
The noncomp spread of negative 2.5% was largely explained by headwinds of 40 basis points from foreign exchange and was primarily due to the weakening pound and its impact on corporate apparel sales.
Moving to gross margin consolidated gross margin was 337 million a decrease of 36 million.
As a percent of sales consolidated gross margin decreased 260 basis points to 42.6%.
Primarily due to lower retail segment gross margin rate.
Retail segment gross margin rate was down 290 basis points to 43.7%.
The decline was primarily due to a 180 basis point decrease in retail clothing gross margin rate driven by increased promotional activity versus last year.
And a 90 basis point de leveraging of occupancy costs.
Turning to expenses.
Advertising expense decreased 5 million and was down 50 basis points as a percent of sales to 4.2%.
Reflecting a shift from broadcast to online spend as we optimize channel mix as well as a shift of some marketing spending to Q3.
SGN aid decreased 9 million largely due to lower incentive and share based compensation expense.
As a percent of sales SDMA was flat at 29.4%.
Operating income of $71 million compared to 93 million last year.
As a percent of sales operating income decreased 220 basis points to 9%.
Net interest expense was 18 million down 3 million compared to last year, reflecting the year over year reduction in total debt.
The effective tax rate was 21.2% compared to 23.9% last year.
And second quarter diluted earnings per share were 82 cents compared to one dollar seven last year.
Turning now to the balance sheet and cash flow.
We ended the quarter with total liquidity of 421 million, which includes 402 million available under revolving credit facility and $19 million of cash.
At quarter end inventories were up 60 million or 8% versus last year.
The majority of the increase is from higher levels of raw materials, including fabric.
Well fabric inventory is higher than planned it is current and in support of basic replenishment product.
Within finished goods and inventory increase at men's wearhouse was largely offset by a decrease at Joseph a bank.
The increase at men's Wearhouse was associated with strategic investments and polished casual categories, including sport coats sportswear and shoes.
A pull forward of fall the seats and lower sales than planned in the suits division.
Importantly, the quality of finished goods inventory as measured by inventory age is significantly improved at both men's wearhouse and Joseph a bank versus last year.
Debt at quarter end was approximately 1.2 billion down $62 million versus a year ago.
On a trailing 12 month basis debt to EBITDA was 3.9 times.
As I mentioned previously paying down debt continues to be a high priority.
Year to date cash flow from operations was 33 million compared to 198 million last year.
The decrease reflects lower net earnings an increase in inventories and rental product purchases and changes in accounts payable and accrued expenses, primarily due to timing.
First half capital expenditures were 39 million up 14 million versus last year and consistent with plan.
While we still expect a modest increase in full year Capex versus last year's 82 million, we will continue to react responsibly to conditions and opportunities in the business.
With respect to real estate during the quarter, we closed a net seven stores consisting of six Joseph Bank stores and one men's wearhouse in Tux store.
The total number of stores at quarter end was 1455.
Turning now to guidance as we discussed last quarter. Our plan is to continue to provide quarterly guidance for the remainder of this fiscal year.
We expect third quarter earnings per share of 40 cents to 45 cents, excluding the impact of any share repurchases.
Our third quarter guidance assumes the following.
For comp sales, we expect men's wearhouse down 3% to 5%.
Joseph a bank down 2% to 4% Kagan, Gi down, 2% to 4% and Moore's down 4% to 6%.
We expect rental comp to be down about 6% as we've lapped last year's big Vanity wedding date in August .
We expect an effective tax rate of 23% to 24%.
With respect to real estate, we expect net closures of seven stores.
Across both men's wearhouse and Joseph a bank.
And finally this outlook excludes expected cost for third party domain experts and other actions associated with our cost savings and operational excellence programs.
Before I turn the call back to Dinesh I want to give an update on where we are in delivering against our multi year cost savings and operational excellence program.
During the first half of 2019, we leverage the expertise of a third party to help us analyze large elements of our cost structure and make recommendations for improvements.
We have already implemented some of these cost savings measures that said the bigger opportunities require thoughtful and rigorous analysis to ensure we continue to deliver a superior customer experience.
While we still have work to do to assess their impact on our business. We feel good about the progress we're making.
We have identified the following major areas of cost savings and efficiencies.
First marketing.
We've begun implementing a more effective marketing mix as we shift from broadcast to digital to tell our brand stories.
Which over time, we expect will be reflected in reduced spending relative to sales.
Second store footprint.
We have previously discussed that we believe we have an opportunity to rethink the number of stores in the fleet and the location of those stores and to do so and analytically rigorous manner.
By the end of this fiscal year, we will complete a comprehensive suite analysis.
Given or 98% of our stores deliver positive four wall contribution. This is much more complex than just close money losing stores.
We are working with a third party to built sophisticated models that will help us make decisions that maximize cross brand cross channel market level profitability.
Third supply chain.
In the second quarter, we consolidated our Canadian infrastructure by closing one of our two distribution centers.
The close distribution center is an owned facility and was recently listed for sale.
The proceeds from which will be applied to our updated capital allocation framework.
In closing while there is more work to do we are making good progress and I'm encouraged by the potential to take significant cost out of the business.
In the meantime, we are focused on shareholder value creation.
Through investing in our growth strategies tightly managing expenses strengthening our balance sheet and repurchasing stock.
Thank you and now I'll turn the call back to the Nash to wrap up.
Thanks Jack.
To wrap up.
On our last call I indicated that we were on a journey to transform our customer facing experience to one that can generate sustainable and profitable growth.
And that we would continue to execute and invest in a focused manner with a clear goal of continuing to generate cash while we transform the experience.
Transformations take time, and we have much work ahead of us to reinvigorate our topline performance.
However, as Youve heard on this call. We are seeing the early signs of customer response to our transformational strategies of providing personalized products and services and inspiring and seamless experiences in an across every channel and brands that stand for more than just price.
We are launching new personalized innovative products for fall, we are driving more traffic to enhance ecommerce experience and we continue to shift more advertising spend from broadcast to digital where we are seeing positive return on investment as we reach customers and more relevant channels.
And while we work to scale these and other transformative initiatives into reliable sources of growth and profit we are delivering on and remain committed to focused investment and execution that generates cash.
Meeting, our financial commitments, while making healthy progress against our transformation roadmap is the result of our team members recognizing that this is not business as usual and not accepting the status quo.
They are changing the way the company executes for the better by being anchored and obsessed with the customer by investing for long term and sustainable value creation.
By using data and analysis to guide decisions.
And by moving with an urgency that reflects our conviction and confidence and our ability to own the customer's loyalty and advocacy.
I'm incredibly proud of the progress the team has made despite the challenging retail environment and couldn't be more excited about the positive customer response, we are seeing and what it means for the journey ahead.
With that let's open the line for questions.
At this time, we'll be conducting a question answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the Q4 participants using speaker equipment. It may be necessary to pick up your handset before pressing the star Keith.
One moment, please while we pull for questions.
Our first question is from Susan Anderson B. Riley FBR. Please proceed with your question.
Good afternoon. This is Lee patent on for Susan.
So you talked about the increased promotional activities in the retail clothing line being one of the main.
Drivers of the gross margin deleverage.
I was wondering if you could provide any more detail on was this promotional activity similar across the brands and then sort of how did it track against your expectations coming into the quarter.
Hi, its actually I'll take that one yes, the as far as the way attract across the quarter, you'll remember when we provided the Q2 guidance and a couple of the inputs that we were using the form that guidance were both traffic and what we were seeing it as a promotional environment at that time.
And as you saw with our results coming in line with guidance that we provided I'd characterize the environment as as promotional.
But not out of line with what our expectations were and Thats one of the reasons, we were able to deliver within guidance.
As far as within the brands themselves I wouldn't characterize them as as meaningful differences in terms of of each brand being.
More or less promotional than the other at say the promotional activity was similar across both brands and consistent with what we saw last year.
Although we continue to and will continue to push on testing, new handles and new price points, but the frequency was similar to last year.
Got it thank you and then.
So sort of looking out into the third quarter I know you don't.
Provide specific gross margin rationale guidance, but given the size of the similar level of comp declines.
Should we be thinking about that.
Sort of tracking the same way for the third quarter here.
Yes, I think Thats fair our guidance for Q3 combined.
A number of inputs, but one is obviously the traffic trends that we've observed for the start of the quarter.
Another is our view of what the promotional environment will be like.
And then the third is the timing of certain strategic cost savings and customer facing initiatives, reaching scale as far as the promotional activity and the traffic as I think those are similar to what we were seeing in Q2.
Got it thanks, and if I could just sneak in one quick one so on the real estate initiative that you that you just spoke on him can you just give us a sense of sort of what the average lease term looks like in the portfolio right now and.
If you're seeing any sort of rent concessions from landlords in your.
A recent discussions thank you.
Hi, Luke this is Jack so lease terms vary by brand I would say in our men's wearhouse business those terms tend to be a little bit longer.
In Joseph Bank, probably a little bit shorter on what we are doing more and more short term renewals, but I would remind you that.
Every year about 15% to 20% of our fleet comes up for lease auction and so we've got a fairly high degree of flexibility to to impact the feet on a regular basis.
Great. Thank you and good luck next quarter.
Thank you.
Our next question is from Paul Trussell Deutsche Bank. Please proceed with your question.
Hi, good afternoon.
Wanted to.
Just maybe dig a little bit more there on the third quarter guidance you spoke.
Positively about some some green shoots you're seeing in regards to.
Some of your initiatives, just maybe reconcile for us.
Some of you know a very similar cadence of comps across each of the banners as we think about the third quarter.
Hey, Paul its dinesh thanks for the question.
As you think about the green shoots that we talked about and that comp guidance, we gave for Q3.
I guess I'd start by reminding you that we are in the midst of a transformation.
And the transformations take time, we are we are approaching this with a test and learn mindset that means we're running experiments at a small number of stores that won't impact the financial results, whether the test as a winner or loser.
The reason we are so excited is because we're starting to see signs of positive customer response to a lot of these tests.
Whether they be in merchandising stores ecommerce our marketing.
It's the scaling of these tests, that's going to drive the top and bottom line impact and some of them like e-commerce youll be able to scale very quickly.
And that's one of the reasons, we talked about the growth we're seeing in the ecommerce business and what we are so excited about.
Others like stores or new merchandise those are going to take more time, given things like production lead times and the nature of physical store Rollouts and so that the impact they have will be happening later.
What we did say, though also as while the customer facing transformation is taking place Weve also committed to to really being focused about our execution and where we're investing with an eye towards generating cash.
And that includes things that can have a near term impact on the bottom line like the cost savings initiatives that Jack discussed as well as continuing to get sharper on our basic business practices, whether that's things like pricing or buying and so the guidance for Q3, particularly at the comp level reflects both of those things the nature and timeline of of transformations.
And the fact that we continue to get sharper and our execution and we will continue to keep you posted on our progress.
Thank you for that color and.
Maybe you can just spend a minute given to a bit more detail on the capital allocation decision made here.
Especially as it relates to.
You know the dividend decision.
And also help us understand.
What.
The decisions you are going to or how you are going to decide to when to buy stock.
Versus paying down debt. Thank you.
Yes, Hi, Paul this is Jack so.
As I mentioned in my prepared remarks, and given where the stock prices and the dividend yield.
We strongly believe that there is a more efficient way of deploying capital then through and through the dividend.
Want to make it clear that funds freed up from the dividend as you mentioned, we will be deployed into a mix of share repurchases and accelerated debt reduction and also just make clear that the funds that we received from the sale of corporate apparel will be entirely.
We'll be entirely applied to.
Debt reduction.
In terms of how we will toggle between those two those two.
Opportunities.
Yes, we will consider a number of variables variables in deciding how to allocate funds between the two.
I would say given our transformation strategies the confidence we have in them.
And our assessment of their risk adjusted outcomes, we do believe that the stock is undervalued based on a DCF methodology.
And we will continue to look at where the stock is relative to those to that valuation as well as where the bonds and the term loan are trading relative to relative to one another to make that decision and it's a decision that we will obviously be revisiting frequently as we move through the months ahead.
Got it.
Looking at Moore's in K G.
Those are segments, we spent a little bit last time speaking to maybe just remind us what's the connectivity there between those divisions and MW.
And banks, how should we view those businesses in terms of.
Core assets and just kind of looking under the Hood talks about.
Some of the trends and initiatives going on within those businesses.
Yes, Paul first with respect to what you talked about on core businesses in prior calls as you know we've talked about the fact that we saw synergies associated with operating our mens Wearhouse, Joseph a bank wars and KMG consumer retail businesses.
And that we did not see synergies associated with operating the dry cleaning business, where the corporate apparel business.
We've obviously sold both the dry cleaning business and the corporate apparel business.
But our view with respect to our consumer retail businesses Hasnt changed we continue to see synergies associated with operating PMDA. The mens Wearhouse, Joseph a bank Morse and KMG and so those remain core businesses as far as the initiatives and when we talk about the various E com initiatives marketing initiatives and those are things that are being leveraged across the portfolio merchandising initiatives and again Thats. Just a further example of the fact that there are synergies and operating these four different retail businesses.
Thank you and lastly from me.
Just as we think about SGN a in advertising dollars.
Down quite a bit.
Into Q.
Maybe just hold our hand, a little bit more as of.
We think about you wanted to make some maybe strategic investments, but also obviously steel.
Looking at different ways to save on costs, how should we think about these line items going forward.
Sure Paul So this is Jack again.
As you mentioned, we don't guide on either advertising spend the rest being able to be helpful. Let me start with advertising.
We expect to see this continue to mix shift from broadcast to online digital and that obviously provides some efficiencies.
But as I mentioned in my comments some of the Q2.
Save.
Versus versus last year.
Was pushed into Q3, so I wouldn't expect as much leverage in Q3 advertising expense.
As you saw in Q2.
With regard to SGN today.
We'll continue to see.
Dollar savings versus last year from some of those same items like incentive compensation and also the other cost savings actions that we've taken that are outside of some of these bigger strategic actions.
Workflow for which we're still doing some work on but in the areas of non merchandise procurement our international shipping travel and entertainment. These are all areas that we've we've attacked this year.
Those savings helped offset some organic cost increases in the business, but as I look to Q3, I would expect sort of flattish dollars and SGN today, but the leverage given the lower sales.
Thanks for the color best of luck.
Thanks, Paul.
Our next question is from Carla Casella Jpmorgan. Please proceed with your question.
Hi, one more question on the capital allocation first on.
D did you give an actual leverage target you mentioned your focus on keeping leverage neutral or bringing it down but did you give an actual leverage target or timeframe.
Yes, so so Carlos as Jack our leverage target of getting to a debt to EBITDA ratio of three times in the medium term is is unchanged. That's still our target as I mentioned that ratio has creeped up a little bit this year with the with the softer business performance, but we are still focused on getting to that three times in the medium term.
Okay, and then on your third quarter guidance that excludes corporate apparel craft.
The third quarter guidance excludes corporate apparel correct.
Okay, and then my the if I'm looking at given the MPS guidance you gave that to me looks like I am fuzzy, but Don low 70 million so is that accurate.
Yeah, We don't we don't guide to we don't guide to EBITDA, but but certainly I think given the components that we've shared around.
Around EPS and the tax rate and some of the comments I've made around.
You know some of the other items I think that you can probably you can probably model that number.
Okay.
And then you you now include rental on I'm, assuming that includes both top and Sue can you give us some sense for how much of that rental income is to first is taxed at this point and is there any major difference between those two this is from an economic standpoint.
Yes, the I don't have the exact numbers off the top of my head Carla, but within the rental business. It is still predominantly a tux business not a not a suit rental business.
And im not aware that the economics between those between renting a suit and renting a talks are are are very different.
Okay, and then just one on cash flow question, there's a there's a big it's about a 100 million use of cash in your working capital that.
For other liabilities.
On.
What is that related to I I was assuming that has something to do with the lease liability changes, which has another offset and the cash flow statement, but just wondering if there's something else going on there and that other liabilities slide I know I think is.
No I think you've captured if the implementation of lease accounting and to your point you should see an offset for that elsewhere in the cash flow statement.
Okay, and one more debt reduction question. So you you mentioned that the $62 million and the carpet OSAT apparel will go towards debt reduction and what are your options in terms of reducing debt you have to buy back in the market and what's your thoughts on term loans versus bonds, given where they're trading.
Sure. So we have we have the option of both.
Repurchasing the notes on the open market as well as executing a call as you know at a premium of one on 175.
So we have the option of doing either of those in terms of the senior notes.
In terms of thinking about the term loan versus the notes I would say at current prices the yields on those instruments are pretty comparable and obviously the notes come due in July 2022, whereas the term loan.
We've extended to April of 2025, so I think our bias would be given given the similar yields our bias would be on the shorter maturity senior notes.
Okay great.
Thank you. Thank you.
Our next question is from Janet Kloppenburg.
Jay JK research. Please proceed with your question.
Hi, everybody just a couple of questions on.
The soup business sounds like custom is really strong if the promotional activity you're talking about in the off the wax business and.
I would ask do you think thats coming more from.
The lack of demand pursuits.
Because of the casualization trend or because department stores off price retailers are.
Trying to gain share and using price as a mechanism and then I had a follow on.
Yes, I'll take the second one Janet you're going have to remind me. The first one what you're asking about on on custom, but as far as as the promotional activity.
Yes, we are seeing heavy promotional activity and suits and that is that something that we saw in Q2. That's something then formed our Q2 guide and.
It's something that we continue we actually saw materialize through the quarter and it's also influencing our Q3 Q3 guide.
That is.
It's going to be driven in part by traffic, which we talked about is.
It remains challenged I'd say for for retail as a whole and then also you met you referenced correctly this trend of casualization.
Which is obviously.
It works against off the rack suits and I would mention though that there is also a trend towards personalization and given that we're playing and custom suits.
That's actually a trend that helps us and it's one of the drivers behind the healthy growth. We continue to see in our custom suiting business, even while that businesses is tracking at a multi hundred million dollar scale.
Okay, and then in terms of the inventory it sounds like it's a little heavy at the men's wearhouse, maybe the content is skewed more to suit Jack I think that's the way. It said in some finished goods as well how do you see that working out.
Getting in line with where it should be and should we assume that the gross margin retail segment gross margin compression. We saw in the second quarter is likely to continue for the remainder of the year.
Hi, Janet I'll take the first part of that.
As far as inventories impacting.
The gross margin.
As Jack indicated in his prepared remarks, the inventories while higher than last year are also have a higher quality as measured by aging and he also indicated a meaningful portion of those were associated a meaningful portion of the increase as I should say is associated with raw materials for basic replenishment program. So.
Because of the nature of that inventory, we havent modeled in any extraordinary promotional activity in Q3 meeting our promotional efforts in Q3, we will continue to be guided by the competitive environment, we need to participate in and not by the current state and levels of our inventory.
Yeah, and Janet this is Jack I would just add to that so just looking forward.
As you know, we don't guide to inventory, but to be helpful. I would say, we expect some improvement.
In the third quarter and the end of third quarter inventories. So we'll expect I would expect that increase versus last year to come down and therefore for the spread between inventory and sales to improve.
And then to expect more significant improvement by the end of the fourth quarter.
And do you see this gross margin pressure moderating as your inventory content skews more to the sport coats and the dress casual, which I think you are expecting to really be impactful on the spring season.
Yes.
The.
The gross margins are obviously.
Lower and our polished casual segments than they are and our suit segments.
So obviously as the as the mix shifts and that'll impact gross margin the offset to that though Janet is the frequency associated with polished casual purchases is obviously much faster and much higher than that associated with suits and so even as you might see an impact on gross margin. We think there is an opportunity for SGN, a leverage associated with higher transaction velocity and polished casual.
So should we expect gross margins will continue to be under pressure for the next couple of quarters and am I right well inventory cost that wont be where you want it to be in the spring season.
Yes, so with regard to gross margin I would expect many of the gross margin headwinds that we experienced in the second quarter will continue into the third quarter Dinesh talked about some of these just in terms of the level of promotional intensity and competitive.
Has it been this out in the market I think we expect that to continue.
With the increased penetration of custom as you remember thats, a lower gross margin rate higher gross margin dollars and obviously with the comps that we've guided to there will be some occupancy de leverage so I would I would expect that.
The gross margin headwinds that we saw in Q2 to largely carry into Q3 and that's been contemplated in our guidance.
Okay.
Thank you so much.
Thank you.
We have reached the end of the question answer session and I will now turn the call back over to international out the President CEO for closing remarks.
Thank you everyone for joining us today, we appreciate your ongoing interest in and support for the important work of transforming our business. We look forward to sharing our continued progress with you next quarter. Thank you.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.