Tailored Brands, Inc. (TLRD) Q1 2019 Earnings Call Transcript

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Tailored Brands, Inc. (NYSE: TLRD)Q1 2019 Earnings CallJun 12, 2019, 5:00 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Tailored Brands First Quarter 2019 Results Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Julie MacMedan. Thank you. You may begin.

Julie MacMedan -- Vice President, Investor Relations

Thank you and good afternoon, everyone. Welcome to Tailored Brands' first quarter 2019 results conference call. This call is being webcast and a replay will be available on the Company's Investor Relations website, ir.tailoredbrands.com. Please note that comments made during the conference call contain 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 Form 10-Q to understand these risks and uncertainties. You can access all of these reports on theTailored Brands' IR website.

In addition, the information on this call speaks only as of today, June 12, 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 are discussed in today's earnings release.

With me today are our President and CEO, Dinesh Lathi and our CFO, Jack Calandra. I would now like to turn the call over to Dinesh.

Dinesh Lathi -- President and Chief Executive Officer

Thank you, Julie, and good afternoon everyone. Earlier today we released our results for the first quarter of 2019 and I'm pleased to report that our earnings per share of $0.21 exceeded the high end of the $0.10 to $0.15 guidance range we provided in March. The better than expected results were due in part to solid outperformance to plan at Jos. A. Bank, which registered only a slight quarter comp contraction of 0.7% that was better than the guided range of minus 3% to minus 5%, and a modest beat to plan at Moores with a quarter comp decline of 4.6%, exceeding the guidance range of minus 5% to minus 7%.

At Men's Wearhouse, we met our guidance range for the quarter at a comp of minus 4.5%. At K&G, a slight quarter comp decline of 0.5% was just shy of the low end of our flat to 2% guided range. In the aggregate, our first quarter retail comp was down 3.2% and at the better end of our internal expectations. Like many retailers who have already reported Q1 results, our Q1 started off slowly and we believe like others that say February was unfavorably impacted by weather and delayed tax refunds. In the combined March and April time period, we saw strengthening in our non-clearance businesses at both Men's Wearhouse and Joseph A. Bank.

While I'm pleased that we were able to exceed our EPS guidance, I'll remind you that we still have work ahead of us, both to transform our customer-facing experience to one that can generate sustainable and profitable growth and to execute and invest in a more focused manner with a clear goal of continuing to generate solid free cash flow while we transform the experience.

When it comes to our customer-facing experience, as we discussed on our Q4 call, it is our belief that men are becoming more style aware and based on our customer research and extensive feedback from our field organization, we know there is a large cross section of men that want a trusted partner to help them look and feel their best. Style awareness is driving the way men think and act when it comes to dressing for the moments that matter, and our mission continues to be about helping men look and feel their best in those moments.

As we execute against that mission, our transformation of the customer experience continues to be focused on delivering personalized products and services, inspiring and seamless experiences in and across every channel, and brands that stand for something more than just price. I'm going to walk you through our progress and plans and (Technical Difficulty) before turning the call over to Jack who will cover financials, guidance for Q2 and our initial progress on cost reduction initiatives.

The first strategic initiative we discussed in March was delivering personalized products and services for a customer who is increasingly demanding personalization and both has online and offline experiences. When it comes to suiting, you can't get much more personalized than a custom-made suit, which is one of the reasons that in Q1 our custom business continued to experience strong growth.

In 2018, we more than doubled our custom sales to over $220 million. We started 2019 strong with custom sales averaging over $6 million per week in Q1 which compares to over $3 million per week in Q1 of last year. The rapid growth we continue to experience at scale is a definitive sign that our custom product and the service we provide is resonating with both existing and new customers.

The significant growth in our custom business supports our view that this suit still plays an important role in a man's wardrobe and given options like custom is a valuable tool for men looking to express their personal sense of style. We believe that our growth in custom continues to be fueled by our superior service, our unique and broad selection, and our ability to deliver product with unparalleled speed. We will continue to innovate along these dimensions to drive further growth.

On the service front, I'm particularly excited about some of the digital innovations we're piloting in stores to elevate the customer's purchase experience by allowing them to see their custom suit selections come to life in real time on an iPad. We initiated this pilot on May 14th and are currently testing this experience in 142 stores across Men's Wearhouse and Joseph A. Bank. We anticipate that the integration of this experience and other technology to enhance the custom selling process will drive sales by improving both customer satisfaction and wardrobe consultants efficiency. The preliminary feedback from store associates is extremely positive and we'll provide additional updates next quarter on the progress of the pilot.

We are also focused on evolving our assortment and merchandising to reflect the fact that the way men are dressing for work and special occasions is changing. We believe suits will remain an important part of our business as they find an evolving but continuing role in the man's wardrobe. However, we also see an opportunity to help men experience the confidence that comes with looking and feeling your best in casual moments by emphasizing our already significant polished casual offering.

In our polished casual assortment in Q1, we saw strength at Joseph. A. Bank in textured and heather sport coats, performance fabric casual pants, knitted and textured casual shoes and performance fabric fashioned polo shirts. At Men's Wearhouse, we saw strengthened soft shouldered sport coats, fashion forward offerings with brighter colors and patterns, and casual shoes.

In future earnings calls, we'll be sharing more details about new product introductions like the Joseph A. Bank 1905 sport coat that incorporates temperature regulating fabric technology and saw encouraging sell-through in Q1, as well as enhancements to our merchandising that will highlight our evolving polished casual assortment.

The second strategic initiative we discussed was creating inspiring and seamless omnichannel experiences. On our store experience, we're making progress on a couple of fronts. On March 17, we initiated the roll out to 80 stores of an enhanced fixture and visual merchandising package. These packages were designed to create a more visually engaging shopping experience and include enhancements like new fixturing and hangers that create an elevated presentation via Life Styling and Faceouts, backlit graphics more mannequins for product storytelling and reduced merchandise on the selling floor to present a more curated assortment. As of May 5, all 80 stores had the packages installed. We're still early in the test cycle, but in our larger footprint test stores we are seeing sales results that give us confidence that our customers will respond favorably to even small investments in an enhanced store experience.

With respect to our portfolio of stores, we're undergoing a fleet wide review focused on optimizing omnichannel EBITDA and we're prepared to take aggressive action. This is not a simple clothes money losing stores type of exercise, since over 98% of our stores are profitable on a four-wall basis. For that reason we will need to develop some robust models to inform our real estate decisions. As indicated in our last call, we'll be working with external domain experts in this area who combine their sophisticated capabilities and proprietary data with third-party big data sets to provide analytically robust recommendations. We will share our real estate plans later this year.

With respect to e-commerce, in March we discussed jump-starting our efforts by engaging a third-party to help us with menswearhouse.com. With their active support we've implemented agile methodologies and have developed and executed against a robust test plan. In Q1, the team executed 26 tests, 11 of which delivered an A, B test validated revenue lift and nine that have been scaled to general availability for all users of our website. The revenue lift has come through a variety of user experience and personalization enhancements which have driven improved conversion and average order value.

Those enhancements include things like displaying estimated delivery dates in the shopping cart, adding badges such as new or growing fast or popular to the product group pages and altering an email requirement for guests check out to appear later in the flow. I'm pleased with what we've accomplished so far and the agile methods we've used to execute. The initial features we've rolled out are increasingly table stakes in the fast moving world of e-commerce, which just showcases the substantial opportunity we have in front of us as we move on to the next level of innovations. This is an area in which we'll both continue to sprint hard and deliver bottom line impact along the way.

The third strategic initiative we discussed was evolving our brands to stand for something more than just price. We feel an evolution is necessary, given research we discussed in Q4 that suggested a heavy historical reliance on promotional pricing had confused the consumer about our quality and relative value. Our brands have great stories to tell. We said we'd work to find a better balance between price promotion and brand storytelling, and do a better job of engaging with the customer and more relevant media channels like paid social.

Since our last call, we executed large scale tests that have provided us with new insights on the efficacy of our broadcast spend in different types of markets, as well as the impact of dramatically increased paid social media spend. The insights from these tests will help guide the shift of our advertising dollars into digital channels in a manner that will drive better returns on advertising spend in the back part of this year and next year.

We also launched new creative campaigns at both Joseph A. Bank and Men's Wearhouse. At Joseph A. Bank, our Get Ready for Greatness campaign acknowledges that the Joseph A. Bank customer strives for and is motivated by achievement. And the clothes that help him look and feel his best provide him with a sense of confidence that fuel his performance. At Men's Wearhouse our Good on You campaign gives a nod to the good in everyone, calls out that when you look good, it shows you care and acknowledges that clothing that helps you look and feel your best, builds confidence for the moments that matter.

The campaigns are both grounded in the idea that confidence, whether it is for work or a special occasion, can come from looking and feeling your best, regardless of your age, your career or your sense of style. This message is consistent with our objective of building brand narratives that appeal on an emotional level and are about more than just price. These campaigns are being leveraged across both broadcast and streaming TV, as well as email and paid social, consistent with our objective of achieving a better balance between offline and online advertising spend.

With that context of progress and plans for our customer-facing strategic initiatives, I'll now turn the call over to Jack who will discuss the financials for the quarter in more detail, our guidance for Q2, 2019 and an update on what we're doing to control expenses and improve operating efficiency while we transform the customer experience.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Thanks, Dinesh, and good afternoon, everyone. Today I'll review the results for the first quarter, our outlook for the second quarter and the progress we are making on our multi-year cost savings program. But before doing so I'd like to provide an update on our exposure to existing tariffs on imports from China, the recently proposed and suspended tariffs on imports from Mexico and the actions we've taken to mitigate any financial exposure to potential new or increased tariffs from either country.

The bottom line is that even if new tariffs go into effect on these goods, we do not expect a material impact on our financial results. Let me explain. First, China. The three lists of tariffs enacted to-date largely do not impact the goods we source and any financial impact from those tariffs is immaterial. If the potential fourth list goes into effect, which would affect virtually all imports from China, we believe we can absorb new tariffs as high as 25% within our existing product cost structure with minimal impact to our bottom line in 2019.

This outlook is thanks to the hard work of our supply chain team which moved quickly last year to diversify our sourcing. For context, in 2017 approximately 30% of our direct sourced product was from China. In 2018 we reduce that exposure to 23% and for 2019 we expect to lower that further to between 18% and 20%. For production that remains in China, we have successfully completed negotiations with those vendors and they have agreed to absorb the majority of any impact.

Second, Mexico. We were obviously pleased with the administration's decision late last week to indefinitely suspend tariffs. That said, given tariffs continue to be a dynamic topic, I thought it would be worthwhile to discuss the status of our imports from Mexico. In 2018 we sourced 9% of our goods from Mexico and we anticipate sourcing about 10% in 2019. We have no plans at this point to relocate any sourcing, but have developed other mitigation strategies should tariffs be levied in the future. These include pulling forward receipts and securing commitments from our vendors to share the burden of any new tariffs. Had the proposed escalating tariffs gone into effect, we believe the execution of these strategies would have resulted in an immaterial impact to our bottom line.

Turning now to the 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 first quarter were $781 million, down 4.5%. Retail sales were down 4% with comp sales down 3.2%. The non-comp spread of negative 1.3% was largely explained by headwinds of 60 basis points from foreign exchange, 40 basis points from lower corporate apparel sales and 30 basis points from the sale of our retail dry cleaning business last March.

Moving to gross margin, consolidated gross margin was $321 million, a decrease of $24 million. As a percent of sales, consolidated gross margin decreased 120 basis points to 41.1%, primarily due to lower retail segment gross margin rate. Retail segment gross margin rate was down 140 basis points to 42.2%. Retail clothing gross margin rate was down 20 basis points and rental was up 70 basis points. The decline in gross margin rate was primarily due to deleveraging of occupancy costs on lower sales and the greater mix of retail versus rental sales this year due to the Easter shift.

Turning to expenses, advertising expense increased $4 million and was up 70 basis points as a percent of sales to 5.8%, reflecting higher broadcast and online spend to support the launch of new brand campaigns for Men's Wearhouse and Joseph A. Bank and more expensive local instead of cheaper national broadcast media to support planned tests. While spend was higher in Q1 in both dollars and as a percent of sales, we expect full year advertising as a percent of sales to be flat to slightly down versus last year.

SG&A decreased $6 million largely due to share-based compensation expenses, T&E and employee related benefit cost. As a percent of sales, SG&A increased 60 basis points to 30.8% due to deleveraging on lower sales. We reported operating income of $35 million compared to $57 million last year. As a percent of sales, operating income decreased 250 basis points to 4.4%.

Net interest expense was $19 million, down $3 million compared to last year, reflecting the year-over-year reduction in our total debt. We also realized $0.9 million loss on extinguishment of debt last year. Our effective tax rate was 33.7% versus 25% last year. The increase was due to higher tax expense related to the accounting for employee share-based awards. First quarter diluted earnings per share were $0.21 compared to $0.50 last year.

Turning now to the balance sheet and cash flow, we ended the quarter with total liquidity of $455 million which includes $425 million available on our revolving credit facility and $30 million of cash. At quarter end, inventories were up $31 million or 4% versus last year. The growth is partially due to an increase in receipts as we're lapping limited shipping container availability in Q1 last year as well as higher inventories in Men's Wearhouse as comp sales came in lower than what was planned at the time of making inventory commitments. Importantly, the quality of inventory as measured by percentage of aged goods is significantly better than last year.

Debt at quarter end was approximately $1.2 billion, down $126 million versus a year ago. On a trailing 12-month basis, our debt-to-EBITDA ratio was 3.7. Paying down debt continues to be a high priority. Cash flow from operations was $12 million compared to $120 million last year. The decrease was largely expected due to the impact of the Easter shift which negatively impacted both cash earnings and working capital.

CapEx spend was $22 million, up $11 million versus last year. The increase is partially due to projects which pushed from Q4 last year and strategic investments in our Men's Wearhouse and Joseph A. Bank stores associated with testing and enhanced fixture and visual merchandising package that Dinesh discussed earlier. While we still expect a moderate increase in CapEx versus last year's $82 million, we have reduced spending versus our original plan and we'll continue to react responsibly to conditions in the business.

With respect to real estate, during the quarter we closed two Joseph A. Bank stores. The total number of stores at quarter end was 1,462. Turning now to guidance, given that we are in the early stages of executing our strategic initiatives and evaluating our cost savings opportunities, our plan is to continue to provide quarterly guidance for the remainder of this fiscal year. Our outlook reflects the recent trends in the business and we expect second quarter earnings per share of $0.65 to $0.70. Our second quarter guidance assumes the following. For comp sales, we expect Men's Wearhouse to be down 3% to 5%; Joseph A. Bank to be down 2% to 4%; Moores, down 2% to 4%; and K&G, down 2% to flat. We expect our rental comp to be down 3% to 4%.

Based on current spot rates, we expect foreign exchange to be unfavorable to sales by about $3 million. For corporate apparel, we expect sales to be down 4% to 6%. We expect an effective tax rate of about 23%. With respect to real estate, we expect net closures of seven stores, weighted toward Joseph A. Bank. And finally, this outlook excludes expected costs for third-party domain experts associated with accelerating our strategic initiatives and our cost savings program.

Before I turn the call back to Dinesh, I wanted to give an update on where we are in delivering against the multi-year cost savings program that I just referenced. In Q1 we engaged a third-party to analyze large elements of our cost structure and make recommendations for improvement. That first phase of work is complete and we are moving on several initiatives that will provide savings in the back half of 2019.

That said, many of the more material cost savings opportunities require additional testing and review to ensure we continue to deliver a superior customer experience and we've developed the timeline to complete this next important phase of work later this year. I look forward to keeping you apprised of our progress in future calls.

In closing, while there is still work to do to get the business back on track, I'm pleased that we exceeded our Q1 guidance. With the progress we're making on our strategic initiatives and the potential cost savings opportunities we've identified, I remain confident in our ability to drive shareholder value creation over the long term.

Thank you. And now I'll turn the call back to Dinesh to wrap up.

Dinesh Lathi -- President and Chief Executive Officer

Thanks, Jack. On our last quarter call, we talked about the fact that transforming our business to deliver a customer-facing experience that can generate sustainable and profitable growth over the long term would take time. We are in the early stages of the transformation and while I am excited and pleased that we are making progress and how our employees have embraced the needed changes, we've still got a lot of work to do.

This is not business as usual and we are not accepting the status quo. As we continue our march toward being the trusted partner that helps him look and feel his best for the moments that matter, our efforts will remain focused on delivering personalized products and services, seamless and inspiring omnichannel experiences, and brand interactions that are about more than just price.

As we execute the transformation, the continuing mandate to the team is to be anchored in and obsessed with the customer, to invest for long term and sustainable value creation, to use data and analysis to guide decisions and to move with an urgency that reflects our conviction and confidence in our ability to own the customer's loyalty and advocacy. Thank you for your interest in and support of our work to transform the Company. We're looking forward to sharing our progress with you along the way.

With that, let's open the line for questions. Operator?

Questions and Answers:

Operator

Great, thank you. (Operator Instructions) Our first question here is from Susan Anderson from B. Riley FBR. Please go ahead.

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

Hi, good evening. Thanks for taking my question. Nice job maintaining the quarter guide this quarter in a tough environment. I was wondering if maybe you could talk about I guess what you're doing from a top line perspective to kind of turn the comps back positive and any color around when you think we should start to see an inflection.

Dinesh Lathi -- President and Chief Executive Officer

Susan, I'll take that question. We are -- as Jack mentioned, we're not guiding the full year comps at this time. That being said, we are excited about the initiatives we've got going on with our assortment, with our stores, our marketing and our e-com. We think they addressed some of the fundamentals in the business about shifts in the way men dress for work and special occasions, shifts in what men expect from the store, shifts to e-commerce and shifts in what men expect from a brand. So, we're focused on what we believe to be the right things. And as a result, we expect that comps will improve during the years we gain increasing traction. on these initiatives.

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

Great. That's helpful. And then maybe if you could talk about how you feel about your inventories. I think last quarter you talked about, you know, still feeling pretty clean out there. You don't feel like you're over inventory and then looking into second quarter, maybe talk about the health of inventory across the brands and your ability to maintain merch margin.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah. Hi, Susan, thanks for the question. This is Jack. So as you know, we finished with our inventories up about 4% in Q1. Two issues really drove that, one was higher receipts versus last year because of that shipping container availability issue that we were anniversarying from last year. But then some of it is, as I mentioned, due to the slower comp sales in Men's Wearhouse than obviously when we made those inventory commitments. I would say that the quality of that inventory is significantly improved versus last year in terms of as we look at the age of those goods. So we feel pretty good about the quality of the inventory, but certainly the inventory is a little bit higher all things considered than we would like.

We don't expect that this point that we're going to have to promote much more heavily to do that. Obviously, we're in a promotional environment and we'll continue to remain competitive. But we don't see the inventory that we have now in terms of either the amount or the quality as being something that's going to put pressure on margins.

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

Got it. Okay that's helpful. And then just one last follow up, if I could. The advertising you talk about the change there, I think shift from national to more local, maybe give a little bit more color on that and what drove that. And then I think also, was there a shift in advertising expense in the first quarter and the rest of the year is going to be lighter?

Dinesh Lathi -- President and Chief Executive Officer

Yeah. So, Susan, on the first part of your question there, around the test that we were running that Jack referenced, that drove the higher marketing expense in broadcast. The rationale there is, we're executing these tests to better understand the efficiency of that broadcast spend. And to do that, we have to do some local on/off for these test markets. And so to do that, you have to buy local TV versus national TV and obviously local is more expensive.

As we described, we're working through those tests right now to land a better balance between offline and digital marketing spend. And so, the expectation is that over the balance of the year we're going to get increasingly efficient with that spend and those tests that we executed well, they did result in more expensive media purchases. Those tests are going to inform that more efficient balance.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah. And Susan. Just to follow-up on the second part of your question, so, yeah, in Q1 advertising expense was a little inflated for the reasons we talked about. In the second quarter we expect advertising expense both in dollars and as a percent of sales to be down versus last year. And on the full year, we're expecting to see some leverage in advertising.

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

Great. Okay, that's helpful. Thanks so much. Good luck, next quarter.

Dinesh Lathi -- President and Chief Executive Officer

Thank you.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Next question is from Paul Trussell from Deutsche Bank. Please go ahead.

Damon Polistina -- Deutsche Bank -- Analyst

Hi, this is Damon on for Paul. Just circling back to the top line, can you discuss the dynamics at Joseph A. Bank for the better expected 1Q results and then looking at 2Q guidance, can you kind of give us color around why we expect kind of Joseph A. Bank to decelerate sequentially in the second quarter?

Dinesh Lathi -- President and Chief Executive Officer

Sure, Damon, let's start with Joseph A. Bank versus Men's Wearhouse and the difference between the two in the first quarter. The main difference in the performance between the two businesses was in the suiting category and custom growth at Joseph A. Bank in Q1 more than offset declines in off the rack suiting and that strength that Joseph A. Bank was really driven by in the custom category. Strength across our entry level in premium price points and performance fabrics. At the Men's Wearhouse, we also experience strong growth in custom. However, unlike Joseph A. Bank it wasn't enough to offset declines in off the rack.

And as far as the guidance for Q2 goes, similar to a lot of what you've heard from other retailers. Q2 started off slow from a traffic perspective. And so our Q2 comp guidance reflects continuation of the trends we saw in the beginning of the quarter. But again, we're confident that the initiatives we're focused on are the right ones to drive comp and as they start to take hold we expect to see improvements in comp as we get further into the year.

Damon Polistina -- Deutsche Bank -- Analyst

Cool, that makes sense. And then just on the rental comp, I think you said down on say 3% for 2Q, can you just talk about the dynamics. Is there any shift in or out of the quarter and what you're seeing in that business.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Sure. Damon, so this is Jack. So, Q1 came in down 6% versus our guidance of down 10% to 12%. So we came in better in Q1. What we've seen develop this year is that actually the prom season was more evenly spread between the first quarter and the second quarter than we anticipated. When we had sort of modeled how the prom build would work for this year, we model against 2014 when we had sort of the same calendar in terms of Easter, Mother's Day and Memorial Day. And actually the phasing this year was a little bit closer to last year than we thought, so we did a little bit better in the first quarter. Some of that obviously comes out of the second quarter. So we still expect it to rebound versus the first quarter, but maybe not -- the difference between the Q1 and Q2 won't be as great. So we're guiding to down 3% to 4% in the second quarter. And just as a reminder, we still expect that business to be down for the year kind of mid single-digits as people continue to shift from rental to retail.

Damon Polistina -- Deutsche Bank -- Analyst

Thanks. And then last one from me, just on the 2Q EPS guide, can you just talk about the dynamics from a gross margin and SG&A perspective, just where we should be modeling those two items?

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Sure. So, yeah, those are (inaudible) we don't specifically guide to, but to be helpful, in terms of gross margin, what I would say is, I would expect gross margin rate to be down versus last year and that's really going to be on occupancy and alterations deleverage. And as maybe we sharpen some of our promotional price points, particularly around some of these big weekends in Men's Wearhouse. So that would be on the gross margin front. In terms of SG&A, I would expect dollars to be flat to slightly down in the second quarter, but the percent of sales to deleverage, just given the comp guidance.

Damon Polistina -- Deutsche Bank -- Analyst

Got you. Thanks guys.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

You're welcome.

Operator

Our next question here is from William Reuter from Bank of America. Please go ahead.

Mike -- Bank of America -- Analyst

Hi guys, this is Mike on for Bill. First can you talk about your expectation for what the rental business is going to be as a percentage of the mix?

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah, Mike. I would say -- in terms of the mix of overall revenue?

Mike -- Bank of America -- Analyst

Yes.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah. So we continue to expect that business to decline I think for this year sort of in the mid single-digit range. And so, I believe in the first quarter that business was about 12% of the total sales. So I think we'll start to see -- as again people choose more retail than rental, we'll probably start to see that business again continue to -- the mix of that business continue to evolve.

Mike -- Bank of America -- Analyst

Got you. And next, obviously you guys have been investing in e-commerce. Could you provide any numbers as to what percentage that is of total sales or what we should expect for the year?

Dinesh Lathi -- President and Chief Executive Officer

Yeah. We don't break e-com versus brick and mortar right now. Just we're managing the business as omnichannel. What I will say though is we know we under indexed to retail as a whole right now which is one of the reasons we see growth in e-commerce a big opportunity.

As we said on our last call, around the middle of Q1 we brought on some new talent and as Jack mentioned we also engaged third-party experts to help us jump-start our efforts in this area. And so as they ramped up through the back half of the quarter, we saw some nice results from some of their early tests that I referenced earlier and that progress has continued into Q2 and so we're optimistic about these efforts contributing to improved comps as we get further into the year.

Mike -- Bank of America -- Analyst

Understood, thanks. And last, could you just talk about your capital allocation strategy and where you look to use some excess free cash flow. Thanks.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Sure. So I would say at this point the capital allocation priorities remain unchanged in terms of investing in the business where we can earn an attractive return, maintaining the regular cash distribution to shareholders which right now is in the form of the $0.72 annual dividend and then paying down debt. That said, as I mentioned in my prepared remarks, we've reduced CapEx spending versus our original plan and we'll continue to react responsibly to conditions in the business there.

Mike -- Bank of America -- Analyst

Great. Thanks so much.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

You're welcome.

Operator

Our next question is from Geoffrey McKinney from Citigroup. Please go ahead.

Geoffrey McKinney -- Citigroup -- Analyst

Hi, thanks for the question. To follow up on those questions, on the dividend I guess, what gives you confidence at this point to continue paying it in light of weaker results. And I guess what would it take to potentially reallocate that capital to improving the balance sheet to provide flexibility to invest in the business going forward?

Dinesh Lathi -- President and Chief Executive Officer

Yes, I would say right now we're very comfortable with the level of dividend that we're paying when we look at our -- at our cash flow and we look at our liquidity. We feel comfortable with that. I think returning cash to shareholders is an important part of our value proposition. Obviously, there's always the debate and the continuing discussion we have with our Board about what is the best way to distribute that cash to shareholders. But I would say at this point we continue to be committed to that. At this point we continue to be committed to that in the form of the dividend.

Geoffrey McKinney -- Citigroup -- Analyst

Okay. And then in light of the inventory increase, how can we think about that for the balance of the year in terms of kind of order magnitude. You've done a great job over the last couple years of releasing capital with that reduction. Should we expect that kind of a similar cadence in 2Q and as we look into the second half of the year?

Dinesh Lathi -- President and Chief Executive Officer

Yes, I would say we did a lot of the heavy lifting in 2017 and 2018 in terms of our inventory and cleaning up our inventory. Obviously, I think the growth in the custom business continues to give us some opportunity to improve turns and increase inventory efficiency.

We're not guiding to Q2 inventory at this point, but to be helpful, what I would say is I expect the sales to inventory spread to improve in Q2 and to continue to improve as we move through the back half. And again, I think it's important just as a reminder that, while the inventory levels are a little bit higher than we would like, the quality of that inventory is much better than it was a year ago.

Geoffrey McKinney -- Citigroup -- Analyst

Okay. And then lastly on -- appreciate the level of detail on the tariffs, I think in terms of being an immaterial impact to the extent a List 4 for was to come into effect, how should we think about the mitigation areas. How much of that is cost sharing with your vendors versus costs that you can potentially pull out of the business versus passing pricing along to the retail customer?

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah. So that the strategies there around tariffs have been, one, as I mentioned, to move or to diversify the sourcing and to reduce the reliance on imports from China. And the team has done a terrific job moving the needle on that just in the past two years. I would say though, we've also been very successful in negotiating a burden-sharing of any tariffs. And obviously that burden-sharing changes whether it is a -- let's call it a 10% tariff or a 25% tariff. I don't want to give the details of that for competitive reasons. But I would say we've been -- we've got to a place where the vendors will absorb a majority of any tariffs that get levied.

Geoffrey McKinney -- Citigroup -- Analyst

Okay. Thank you.

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

Welcome.

Operator

This concludes the question-and-answer session. I would like to turn of floor back over to management for any closing comments.

Dinesh Lathi -- President and Chief Executive Officer

Thank you for joining us today. We appreciate your ongoing interest in and support for our work to transform our business. And we look forward to sharing our continued progress on our customer experience and cost saving initiatives next quarter.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.

Duration: 44 minutes

Call participants:

Julie MacMedan -- Vice President, Investor Relations

Dinesh Lathi -- President and Chief Executive Officer

Jack Calandra -- Executive Vice President, Chief Financial Officer and Treasurer

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

Damon Polistina -- Deutsche Bank -- Analyst

Mike -- Bank of America -- Analyst

Geoffrey McKinney -- Citigroup -- Analyst

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