Lands' End, Inc. (LE) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Lands’ End Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference call over to Bernie McCracken, Chief Accounting Officer. Please go ahead, sir.

Good morning and thank you for joining the Lands’ End earnings call for our fiscal second quarter 2016 results. On the call today you will hear from Federica Marchionni, our President and Chief Executive Officer; and Jim Gooch, our Chief Operating Officer and Chief Financial Officer. To begin our prepared remarks, Federica will discuss the current state of the business, and then Jim will provide details on our second quarter performance. After the company’s prepared remarks, we will conduct a question-and-answer session with our covering analysts. Please note that this morning we released our fiscal second quarter 2016 earnings results, which are now available on landsend.com. I would like to remind you that today’s discussion will contain forward-looking statements related to future events and expectations. These statements are based on current expectations and the current economic environment or are based on potential opportunities. Actual results may differ materially from those expressed or implied in the forward-looking statements. Factors that could cause the company’s actual results to differ materially from those discussed are posted in the investors’ information section of landsend.com and in our most recent SEC filings. Our discussion will also include certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures also can be found in the investor information section of landsend.com. Any reference in our discussion today to EBITDA means adjusted EBITDA as defined in the earnings release. Lastly, we assume no obligation to update the information presented on this call except as required by law. I will now turn the call over to our Chief Executive Officer, Federica Marchionni.

Good morning and welcome to Lands’ End second quarter 2016 earnings conference call. I will begin with some highlights from the quarter and then focus on our progress across our key initiatives. Overall, we saw sequential improvement in the second quarter compared to the first quarter. Sales totaled $292 million, down 6.5% compared to last year’s second quarter. May and June were the best performing months with positive year-over-year performance in June. In July, our sales were impacted by a lower level of promotional activity, as well as reduced level of markdown inventory compared to last year. Gross margin expanded 30 basis points during the quarter, and we also controlled expenses, which led to adjusted EBITDA for the quarter of $7.3 million. Jim will talk about this more in detail in his financial review. During the quarter, we continued to make progress on enhancing our distribution channel to drive near-term and long-term performance. We were pleased with the performance of our May and June catalog, driven by our strong presentation of core product, as well as our promotional and pricing presentation within the book. Strong sell-through of swim and shorts early in the quarter resulted in less markdowns inventory in July, as I mentioned earlier, which led to higher gross margins for the quarter. We saw favorable results, as we took learning from the recent changes we have made to our catalog, which have allowed us to target our active customers, as well as win back lapsed customers. They demonstrate that we have a competitive offer and that our customers who have shopped with us in the past are responding favorably to our enhanced product. As we look ahead, we will continue to enhance our product offering, which remain our first priority, as well as refine our marketing initiatives, including elevating our product presentation and messaging. On the commerce front, we have continued to roll out our multi-branded website shopping experience. In addition to an online segment dedicated to our Canvas by Lands’ End brand, we recently launched additional segments dedicated to our Lands’ End Sport, school uniform, business outfitters and Lighthouse brands. These efforts are designed to expand brand awareness for Lands’ End overall and broaden our customer base. We can now leverage this differentiated site to target consumer with a more personalized experience with something that’s relevant to their needs. As we look to the holiday season, we’re excited to launch our new mobile application, as well as an improved online shopping experience on our e-commerce site. In our retail location at Sears we saw improved performance versus prior quarter, driven by our core products and enhanced inventory control. The Lighthouse by Lands’ End retail comp sets continue to perform well in our fast locations. Customers are responding favorably to both the new retail concept, as well as the new brand name and the product offering. We’re working to increase our efficiencies across our Sears store base, so that we can roll out Lighthouse by Lands’ End to the current Lands’ End base at Sears in a very successful way. We anticipate that the roll out will take place in the fall of fiscal 2017. We are pleased to be partnering with Amazon to present our Lands’ End Sports, footwear and a native [ph] collection of Canvas by Lands’ End beginning by the end of September. This provides an additional channel for us to introduce consumers to our new brand and expanded category. Our Outfitters business was softer than expected during the quarter, mirroring our performance in the overall business. Outfitters space is challenging in July, which we believe is due to parents waiting to buy back-to-school items until closer to need or foregoing their purchases. However, corporate remain strong. We are working hard to expand our current business and seek new partnerships, both with major corporations and schools. Finally, while information is an important opportunity for the company over the long-term, the business was tough during the quarter, driven by lower consumer spending for our most recent catalog and promotional offering. In addition, we saw consumer concerns, both leading up to and following the Brexit vote in the UK, which impacted our European business. As we look ahead, we remain focused on our key priorities beginning with product. We continue to evolve our merchandise assortment, offering quality, value, and style, in products that appeal to our customers lifestyle. Our focus is an increasing product relevance and reinvigorating the assortment with greater design appeal and innovation in our traditional styles. We also remain excited about the opportunity in our new Canvas by Lands’ End brand, which is targeting a more and modern customer, but still embodies the Lands’ End DNA. We believe that there are areas of our core assortment that we can continue to enhance. One such opportunity is working to expand our core best seller, including outerwear, sweaters, and men’s. This will be key for us as we get into the back-half of the year. Our focus in outerwear will highlight both value and function. Within sweaters, we’ll introduce updates to key items and new colorful styles at key price points. .: In addition to focusing on our core offering, we are also continuing to build the Canvas by Lands’ End assortment, which we hope will start to create an halo effect for the overall Lands’ End brand. We are working on initiatives that will encourage cross-shopping for our Lands’ End customer with a Canvas by Lands’ End brand. As we look ahead, we will present a fresh collection for the fall and holiday, featuring coats, sweaters, and blouses in new silhouettes and beautiful fabrics. To garner excitement for our product offering and support the work we are doing will enhance our distribution channel. We have launched a number of marketing initiatives aim at presenting our entire portfolio products to the customers. For Lands’ End, we showcase our core product offering, we are using our greatest spokes people, our Lands’ End customer to tell their story. We recently launched a pop-up customer campaign, which put customer stories from and center in all communications. While for our Canvas by Lands’ End brand, we recently debuted a new campaign, which features actress Emma Roberts and was shot by famed photographer Mario Testino, showcasing our new products to the younger consumer. In addition, we’re focusing on collaborating with social media influencers to increase visibility. We have also formed a digital media partnership to create a custom four-week social program to drive awareness and engagement with select publications, prioritizing historical best performance with social expansion capabilities. We will continue to foster direct relationship with social media influencer to develop unique content and generate new followers, as we look to expand brand awareness for Lands’ End. We successfully opened a pop-up store in Southampton for August, and we plan on opening an additional pop-up location in New York City’s, Soho neighborhood during Fashion Week, which will stay open through the holiday season. In addition, we will be opening a new premium outlet store in Aurora, Illinois in October. We believe this new retail locations will help drive traffic and awareness to our brands. I’m very pleased the products from our recently launched back-to-school campaign will feature on Good Morning America. It’s a positive response to the coverage from both our existing and new customer. We have also made good progress enhancing our supply chain and are working towards reducing our lead-time to nine months on average and for certain items, create a fast track with even short and lead times. We are also making improvements that we believe will enhance service and quality, as well as ultimately lead to a reduction in product cost. Overall, we have continued to make progress enhancing our product offering, elevating our marketing strategy, and improving our distribution channel. While we have not yet achieved the turning point in terms of our financial results, I believe that we are moving the business in the right direction. We are creating a culture of action within Lands’ End and empowering our talented management team to execute our strategy. And I’m very proud of the work that our team has done and continues to do, as we work to position the business for profitable growth. Thank you for your time this morning. And with that, I’ll turn it over to Jim to review our financial results for the quarter.

Thank you, Federica, and good morning. I’ll start by walking you through our financial results for the quarter. Revenue for the second quarter was $292 million, that’s down 6.5% compared to $312.4 million last year. The sales decline was comprised of a 6.9% decrease in the Direct segment, with sales of $246.4 million and a 4.3% decrease in the Retail segment, with sales of $45.5 million. The decrease in the Direct segment was driven by the decline in both the U.S. region and to a lesser extent international business. The U.S. business realized negative comparable sales in the second quarter, as Federica discussed, May and June were significantly improved versus our prior trend, but that improvement was offset by a disappointing July. As a result of our strong performance in May and June, we ended July with a lower level and a higher quality of inventory. We remain focused on offering more preplanned and targeted promotions and maintaining clean inventory levels, and we made the strategic decision to be less promotional in July than last year. In addition, we believe we’re also less promotional in the overall retail industry. While this lower level of promotion impacted our sales performance, driving less markdown sales during July, it benefited our gross margin, and I’ll talk about that shortly. The decline in the Retail segment reflected a 2.5% decrease in same-store sales, combined with five fewer Sears locations. We ended the quarter with 224 shops at Sears. Our retail performance was driven by a strong Memorial Day, favorable weather, and targeted more timely promotions. This was offset by continued traffic challenges within malls and specifically within our Sears locations. As we discussed in the past, currently our largest traffic driver is our catalogs. During our discussion last quarter, we outlined a number of changes that we’re making to our catalogs, including changes to both the product and promotional presentation, as well as increasing our circulation. For the quarter, we were able to stabilize our active buyer file, as well as improve our reactivation rates, turning lapsed buyers into active ones. In May and June combined, we realized a significant improvement in trend in our customer metrics, with a slight increase in active buyers and double-digit increase in reactivating lapsed buyers. We recognize that we still have a lot of work to do. We’ll continue to apply the learnings we obtain about our customers, while we read and react to the overall market conditions. We expect to see sequential improvement throughout the remainder of the year. However, with the continued highly promotional competitive environment, we do anticipate results will remain under pressure. Gross margin is the area of the business, where we saw the most significant sequential improvement with a 30 basis point year-over-year increase to 46.6%. Gross profit was $136.2 million compared to $144.5 million in the same period last year. The Direct segment gross profit decreased 5.9%, while gross margin in this segment increased 50 basis points to 47.1%. In the Retail segment, gross profit decreased 5% and gross margin decreased by 20 basis points to 44.2%. Our gross margin rate reflects the impact of the revenue trend during the quarter. Again, as a result of the strong performance in May and June, we operated during July with lower inventories, driving lower markdown sales, and lower corresponding clearance markdowns. As I mentioned earlier, we made the strategic decision to be less promotional during July. This led to the improved margin rate year-over-year, as well as a significant improvement in gross margin trend compared to the first quarter. Looking at selling and administrative or S&A expenses for the quarter, it increased 3.2% to $128.9 million, compared to $124.9 million last year. Total S&A expenses as a percentage of revenue increased by 410 basis points to 44.1%. The higher cost this year were attributable to an increase in marketing expense during the quarter, specifically, as we previously discussed, we increased catalog circulation during the quarter and also brand advertising, mainly to help introduce, both Canvas by Lands’ End and Lands’ End Sport brands. These higher marketing costs were partially offset by continued reduction in our variable expenses. Operating income was $2.7 million compared to operating income of $17.9 million in the second quarter of 2015. Income tax benefit for the second quarter was $1 million, compared to income tax expense of $4.7 million for the same period last year. That results in a net loss for the second quarter of $2 million, or a loss of $0.06 per share compared to net income of $7.5 million, or $0.23 per share in the second quarter of last year. In addition to the GAAP measures that we’ve outlined above, adjusted EBITDA is an important profitability measure that we use to manage our business internally. For the second quarter, adjusted EBITDA was $7.3 million, and that compares to adjusted EBITDA of $19.6 million in the second quarter of 2015. Now, let’s take a look at the balance sheet. Total cash and cash equivalents at the end of the quarter were $210.7 million, compared to $208.4 million last year. Inventory at the end of the quarter was $354.7 million, which is $13.1 million, or 3.6% last – in the second quarter last year. As I’ve discussed our strong performance in May and June left us not only with a lower level of inventory, but also a healthier overall inventory position. Long-term debt decreased to $491.9 million, as compared to $495.7 million at this time last year, with the reduction mainly due to the quarterly principal payments. Looking at operating cash, year-to-date in 2016, it was $1.7 million, which compares to $3.4 million in 2015. Before I open up the call for questions, I want to reiterate a few points that we discussed previously. First, we’re continuing to maintain our prudent cash management, while making strategic investments what we believe we can yield a positive return. Next, as I mentioned earlier, catalog circulation increased in the second quarter. We plan to optimize our circulation, continuing to use our catalog over the remainder of the year to help rebuild our customer file, focusing on both our active and lapsed customer base. While our second quarter results didn’t meet our expectations, we recognize that it may take sometime to build back our lapsed customers and attract new ones. But we’re encouraged by our initial results, as they illustrate the improvements we’ve made and how we communicate with our customers. Finally, we plan to continue our capital investment for our ERP system, where our initial focus is on our finance functions, merchandising operations, and our inventory planning systems. Now, we’ll open up the call for questions.

[Operator Instructions] Our first question comes from Steven Marotta with C.L. King & Associates. Your line is open.

Good morning, Federica and Jim.

Good morning.

Just – your last commentary regarding circulation, I’m trying to understand if circulation – if the intent of circulation in the third quarter and the fourth quarter will increase in a similar fashion, as it did in the second quarter?

Yes, I think, what we’ve said on last call is still consistent, Steve. If you go back, we had a decrease in the first quarter. We saw an increase in the second quarter. We anticipate a similar increase in the third quarter, and then the fourth quarter, it should stabilize and be relatively flat. So for the overall year, we’re still anticipating the catalog spend to be relatively flat for the year.

Okay. And then the current inventory composition, given the fact that, I mean, the good news is that, May and June were relatively promotional from an environment standpoint, you may not have participated as much in it, which is a really good thing, and your sell-through based on product in May and June was quite strong. Given the commentary for the balance of the year, it is true that I would also expect the promotional environment would be similarly heightened from an environment standpoint, but can you talk a little bit about your intent and current inventory composition, as a result, could we see the same dynamic occur in the back-half of this year as occurred in May and June?

Well, a few parts maybe to your question there. First, from an inventory composition, as I said in my comments, we’re very pleased with our overall composition of inventory. During May and June, we did have increased circulation and we did participate from a promotional perspective in May and June. Our reductions in promotion, I would say, were more heavy in July, where last year, we were probably over-promoted. Last year, we entered July with excess inventory and we had to be extremely promotional in order to liquidate the inventory. Fortunately, this year we didn’t have that issue, better overall inventory management throughout the first quarter into the second quarter. We had made the decision going in that we weren’t going to be promotional. And then with the lift and the strong performance in May and June, we did have some out-of-stocks when you look at SKU and color, and therefore, we did not increase our promotional cadence in July. As we go into the back-half, you’re going to see an increase circulation in in third quarter. So I would say that we will be appropriately promotional in the third quarter. In the fourth quarter of last year, we had very little promotions in the first part of the quarter. We’re very heavily promoted in December. I think, this year they will be more timely, they will be better preplanned and more thoughtful and more consistent across the quarter.

Okay, that’s helpful. And Federica, you mentioned that one of the focus is on sizing, I believe, and can you talk a little bit about your SKU management overlaid with that commentary? How can we feel confident that that if you add extra sizing that you’re not adding extra SKUs, which could cause inventory risk going forward? Thank you.

Good morning, Steven. As I said since the shareholder meeting, the first one streamlined merchandising is a key element of the strategy. So we need to reduce every inefficiency in inventory. And I think, we’re doing a good job in that in eliminating everything that is not productive, so that’s our SKU level. We’ll maintain the same level that that we used to have. So we know that we can manage that. So I think this is what we are doing and we’re very pleased so far that we could be able to launch new lines, focused more on footwear launching the Canvas by Lands’ End line, the Lands’ End Sport and still maintaining the same level lower inventory and SKUs.

That’s very helpful. And then one more question, Federica, you mentioned that you currently are targeting a nine-month lead time for a product. Can you talk about what it is right now and when you expect it to get to the nine-month level? Thank you.

We are already in the nine-month, but it was a huge effort to get into that for the season – for the spring 2017 season. So we need to do a better job in making sure that all the pieces that all the departments that working towards developing and producing the product will be able to have enough time to create the best possible offer. And because sometimes trends and we want to be on trend for parts of the collection, and sometimes those trends are just last minute. And so we need to be able to capture them and that’s why we’re creating a fast track, which is a little lower than the nine – than nine-month, but of course, it’s for a tiny part of the business. But it’s very customary, let’s say, in the industry for companies that also have not just the timeless product, but also product that are on trend.

That’s great. You’ve spurred one more question considering that you have a nine-month lead time for the spring of 2017, have you targeted reducing that for your fall 2017 collection, and if so, where do you think you’ll be in fall 2017?

We are not a fast fashion, so I think nine months is a good target. As I said, the point is to give enough time to the different parts of the pieces, the supply chain to get into the nine months. Then if and I don’t think that it’s our case. We will monitor if the part of the trend collection will be more substantial then we need to reduce also that lead time, but at the moment we don’t anticipate that that will happen in a major way.

Ladies and gentlemen that does conclude today’s question-and-answer session. Thank you for participating in today’s conference call. This concludes the program, and you may all disconnect. Everyone have a great day.