Lands' End, Inc. (LE) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Lands’ End Second Quarter Fiscal 2017 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 be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the call over to Bernie McCracken, Chief Accounting Officer. You may begin.

Good morning, and thank you for joining the Lands’ End earnings call for our second quarter fiscal 2017 results, which we released this morning, and can be found on our website landsend.com. On the call today, you will hear from Jerome Griffith, our Chief Executive Officer; and Jim Gooch, our Chief Operating Officer and Chief Financial Officer. After the Company’s prepared remarks, we will conduct a question-and-answer session with our covering analysts. Please also note that the information we are about to discuss includes forward-looking statements. Such statements involve risks and uncertainties. The Company’s actual results could differ materially from those discussed on this call. Factors that could contribute to such differences include, but are not limited to those items noted and included in the company’s SEC filings, including our annual report on Form-10K and quarterly reports on Form 10-Q. The forward-looking information that is provided by the Company in this call represents the Company’s outlook as of today, and we do not undertake any obligations to update forward-looking statements made by us. Subsequent events and developments may cause the Company’s outlook to change. During this call, we will be referring to non-GAAP measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP measure can be found in our earnings release issued earlier today, a copy of which is posted in the Investor Relation section of our website at landsend.com. With that, I will now turn the call over to Jerome Griffith.

Thank you, Bernie, and thank you everyone for joining us today. We’re very pleased with the progress that we made on several initiatives during the second quarter, as evidenced by positive results across a number of key metrics. We saw improved performance in our U.S. Consumer business, positive comps on our Retail business, stabilization in international markets and significant improvement in our customer files. Throughout the quarter, we remained focused on delivering a consistent brand vision across our business and took steps to further enhance our product offering, marketing strategy and customer engagement. Jim will review the details of our financial performance shortly, but let me provide a few highlights from the second quarter. We continue to successfully invest our marketing dollars into working digital and print media, which drove traffic and strong customer response. This effort contributed to double-digit growth in our overall customer files attributable to both our lapsed and new customer files as well as mid-single-digit increase in our active customer file. We once again saw improved trends in our U.S. Consumer business led by positive consumer response to our swimwear offering as well as strength in women’s apparel, particularly bottoms; men’s woven tops; and our home category. In addition, we saw double-digit increases in our U.S. e-commerce sales, which is our largest distribution channel. In our Retail channel, we posted another positive same-store sales comp increase in the quarter, driven by swimwear, men’s and women’s bottoms and the tops. In addition, our international business performed well as a result of more segmented marketing. Overall, while still in the early stages of our strategic plan, we’re pleased with our progress. Importantly, we believe we’re headed in the right direction as we continue to execute on our strategic priorities. As we look ahead, we’re focused on four priorities that will enable us to strengthen the Lands’ End market position over the long term. These include driving growth across our business, establishing a customer-centric culture, elevating our business processes and improving our infrastructure. First and foremost, we want to drive growth across our business. A key part of this will be enhancing our assortment with relevant and compelling products that meet the quality and fit standards that are reflective of the Lands’ End heritage. We’re committed to not only meeting, but exceeding the expectations of our customers who are looking for clothing that’s comfortable and functional, that serves the need within their wardrobe and fits into their relaxed lifestyle. That is what we strive to deliver. Importantly, they want newness. They love our classics, but they also want an updated look that fits well and matches their style. While we still have work to do, we’re making progress, and I believe we’re in a much better position from a product development perspective than we were at the beginning of the year. We see a strong response in outerwear and swimwear where our customers recognize our core competencies and quality offerings. At the same time, we’re also focused on driving our pants and knits businesses where we feel there is a great opportunity for us to be the clear leader in the marketplace. These products are inherently more technical in nature as the fit and function need to be just right, and we believe that we have the ability, talent and insights to own these categories. While we believe that it will take a few seasons to more fully impact our assortment through our focus on these four core categories, the product is evolving, and as I said earlier, we have seen encouraging results thus far. Additionally, returning the company emphasis to key item businesses has shown positive early results for fall 2017. Franchise items like the pencil pants, the Starfish pants, the Knockabout Chino, the Bedford pullover and the Sherpa hoodie have all shown strong early sell-throughs. We will continue the strategy of offering stylish quality items at fair prices, reverting to the expectations of the core Lands’ End customer. Importantly, our focus on key items in these categories is designed to enable us to command a better margin and higher average ticket over the long term. Not only will we continue the work that we have been doing to update our merchandise assortments within our current categories, but we will also look to extend our offering into areas where we see whitespace. We will, of course, only do this in ways that makes sense for our brand and our customer. Examples include expanding our home product offerings and soft leisure clothing. Where and how we sell our products is just as important as which product we sell. A primary focus of our growth initiatives is to build upon our e-commerce and digital capabilities. For many years, we’ve operated as a catalog business with a complementary online e-mail and digital presence. We’ve been working to shift the relationship among these direct channels and bring our marketing expertise to the digital world. To do this, we will first focus on upgrading our technology platforms. Currently, we utilize multiple e-commerce platforms across our business, and we will work to rationalize and enhance this key infrastructure in the future. We also intend to integrate emerging technologies so our customers have the tools necessary to easily explore, shop and utilize and share social feedback on our products regardless of the device they use. Finally, we’re investing our marketing spend to attract online shoppers with improving results. As we noted on the last quarter’s call, we are also working to refine our retail store strategy. We’re committed to putting our retail destiny firmly on our own control over the long term. This will help to ensure that we’re giving our customers what they want, while also giving them the options to buy it, exchange it and return it when and where they choose, whether that be online or in person. As you know, Sears has been closing store locations over the past several years, and we have been preparing alternative strategies to best serve our bricks-and-mortar customers. As part of this, we have a preliminary plan to open several of our own stand-alone Lands’ End stores in fiscal 2018. Given our long history of serving customers across the country through our catalog and online, I can confidently say that we have a very good grasp on the needs of our customers. We will leverage this data to inform our decisions and create differentiated experiences as we open new locations. Our second priority is to become an even more robust customer-centric organization. We’re working to apply the latest direct marketing principles to our e-commerce platform as well as to our product and digital marketing messaging. This will be driven by a cultural and process transformation using advanced analytics to improve decision-making and enhance our focus on the customer. As an organization, we’re getting much better at testing and reacting to selling trends, customer data and website metrics. We expect to continue to elevate these capabilities going forward. This will be evident both in our merchandise offering as we strive to create assortments that better reflect our customers’ sensibilities and needs as well as through our marketing efforts, which will be focused on making the customer experience more personalized and relevant. As I mentioned earlier, we’re working to better align our marketing investments with media that our customer is responding to and leveraging data to help improve execution and productivity. We’re very pleased with the results we’re seeing so far. This includes reallocating dollars to some more traditional methods and making progress in newer areas, such as social media. For example, we saw great success around recent events, such as our National Swimwear Day and Backpack Birthday campaign, which offered a special promotion to celebrate 50 years of the backpack. We will also use the data we’re gathering to enhance customer experiences, enabling us to more easily personalize customers’ interactions with Lands’ End. We believe this will ultimately allow us to create deeper connections, improving customer satisfaction and drive higher conversion. As an example, we’re seeing success personalizing e-mails by leveraging individual browsing behavior at the time of day they typically open their e-mails. In addition, we’re taking steps to strengthen our omnichannel capabilities to make it easier for customers to find, shop and buy products that fit their needs. This includes continuing our shift towards becoming an e-commerce led business through enhancements to both our online and mobile experiences. For online, we’ve removed the segmentation of brands and improved product sell-throughs to ensure the most relevant products are presented to our customer. In addition, while we’re pleased with the progress we’ve made so far, we see opportunities to further improve customer engagement and use the user experience for customers shopping Lands’ End from their mobile devices. We’re creating an easier mobile shopping experience with a cleaner design to enhance navigation, quicker load speeds and options to get order notification straight to your phone via text message. We believe that these improvements will significantly impact both mobile traffic and conversion. Customer service is another area of focus as we look to deepen our level of engagement and differentiate our brand from mass retailers and market places. While we already provide award-winning customer service, we’re working to reimagine the shopping experience as we strive to delight and surprise customers every time they engage with Lands’ End across channels. We’re evaluating capabilities that will allow us to position data-driven customer sentiment insight into the hands of our employees, so they’re fully equipped to meet our customer’s expectation. This will be an ongoing process to ensure that we are continually meeting our customers’ needs. In the near term, we’ll be focused on helping customers find the right item through enhanced fit and product finder solutions. This includes our proprietary interactive Swim Finder and swim mix-and-match tools, which are generating great feedback. We’re also excited to introduce more tools for the fall and holiday seasons, which will make the shopping experience more efficient for our customers. Our third priority is updating our business processes. We’re working both internally and with vendors to shorten lead times, which will better position us to deliver product that aligns with customers’ needs and current trends. This will also enable us to chase key trends during the selling season. That said, this is a process and it’ll take some time to realize the full benefit. Beginning with our fall 2018 shipments, we anticipate that we’ll be able to cut our lead times by about 25%, and we’ll look for opportunities to reduce those further as we head into fiscal 2019. We are also working on SKU optimization to improve our overall inventory productivity. Our goal is to improve inventory quality in order to deliver a more relevant assortment to our customers on a consistent basis. Finally, we’re focused on further strengthening our infrastructure to increase efficiency across the organization. We’re already benefiting from the first phase of our ERP upgrade, rolling out our finance and merchandising operation system earlier in the year. We expect to implement additional finance and merchandising operations capabilities along with inventory planning capabilities later this year. We believe these foundational systems will provide us with a springboard for strategic capabilities, including order management and warehouse management, allowing us to operate as a global omni-channel player. Overall, we’ve launched initiatives to drive improved performance across the organization, and we’re pleased with the progress that we’re making in the business. It’s very encouraging to see the growing momentum at Lands’ End. As we look ahead, we will continue to selectively expand across categories emphasizing businesses where we have core competencies and grow our cost distribution channels as we enhance our focus on the customer and elevate our business processes and infrastructure. We have a great team in place and they’re executing on these priorities, and we look forward to updating you as we move forward. Overall, we continue to believe that Lands’ End is a strong global brand that is well positioned for future growth and continued success as an omni-channel retailer. With that, I’ll turn it over to Jim to review our financial performance.

Thank you, Jerome, and good morning. We are pleased with the continued progress that we made in the second quarter. Revenue for the quarter increased 3.5% to $302.2 million, compared to $292 million in the same period last year. Importantly, we continue to see improvement across a number of areas, particularly in our U.S. Consumer business as well as our retail comp stores. Sales in our Direct segment increased 5.5% to $259.9 million and retail sales decreased 7.4% to $42.2 million. In terms of our product, as Jerome mentioned, sales in swimwear were strong as customers responded well to the enhanced innovation. Our women’s bottoms, men’s woven tops and home categories also saw strong sales increases during the quarter. We’re pleased that new customers are coming into the brand through many of our categories, specifically in women’s where we’ve seen our Beach Living products really resonating well with current and new customers. We’re also happy with the performance of our non-swimwear items, such as our Starfish pants and our extended-size women’s bottoms as well as various home offerings. We’ll continue to work to further enhance our offering across all categories, and as we head into the fall season, we see further opportunity in our home products, our transitional outerwear, bottoms and women’s tops. We continue to make strides in improving traffic and conversion, which we attribute to a number of factors. First, we further reallocated our marketing dollars to our most effective media channels, focusing on digital media and our catalog, which helped to drive traffic. Second, we maintain the disciplined strategic approach to our promotions, utilizing a test, learn and react approach, improving our promotional productivity and profitability. And third, we continue to see a positive impact from the refinements we made within our catalog, helping to drive improved conversion. We’re very pleased with the continued positive momentum in our buyer file. We are able to stabilize our buyer file over the last several quarters, and during the second quarter, we once again saw growth among existing customers and double-digit increases in both reactivating lapsed customers and capturing new ones. We attribute these results to overall enhancements with our customer experience and optimization of our marketing investment to ensure that we are reaching our customers through the most effective and efficient means possible, while offering improved products at values that resonate with our consumers. Despite some timing shifts in our national accounts between the quarters, we realized a low single-digit increase in our outfitter business. We continue to work with Delta and expect to launch a new uniform line either at the very end of fiscal 2017 or early 2018. Finally, turning to our Retail business, same-store sales were positive in both Sears locations and our stand-alone stores, with a combined increase of 4%. Overall, this increase was offset by the impact of closing 20 Sears locations since the second quarter of last year. We ended the quarter with 204 shops at Sears. The increase in same-store sales was due to our enhanced product offering as well as strong consumer response in our marketing and promotional efforts. As Jerome mentioned, we’re taking steps that will put our destiny in the retail channel more firmly in our control by beginning to open our own stores in 2018. It’s worth noting that in fiscal 2016, the Lands’ End shops at Sears accounted for revenue of approximately $165 million or 12% of our total revenue and comprised approximately 90% of our Retail segment. However, for fiscal 2016, our Retail segment generated a negative adjusted EBITDA of $5.6 million. Our stand-alone retail locations are generally profitable, and we believe that focusing on building out our Retail business is the right move for our customer over the long-term. Gross profit was $134.2 million, compared to $136.2 million last year. Gross margin declined 220 basis points year-over-year to 44.4%. Overall, we believe our initiatives to enhance our promotional cadence and rationalize our offers are having a positive impact on the business as our year-over-year product margin trends were in line with what we saw in the first quarter. However, increases in shipping and net duty expense as well as FX negatively impacted gross margin by approximately 140 basis points during the quarter. The Direct segment gross profit declined 0.9% and gross margin in this segment decreased 290 basis points to 44.2%. The decrease was largely driven by the items I just mentioned as well as increased discounting in a highly promotional environment and liquidation of select styles, particularly in footwear and in kids. In the Retail segment, gross profit decreased 5% and gross margin increased 120 basis points to 45.3% due to promotional productivity and a timing shift to certain liquidation activities from Q2 last year to the third quarter this year. Selling and administrative expense decreased 1.2% to $127.3 million, the $1.6 million decline in selling and administrative expenses was primarily the result of lower marketing and other variable expenses. Despite our increased sales, we were able to reduce our costs and realize more than a 200 basis point improvement in variable expenses. These decreases were partially offset by an incremental $1.9 million incentive accrual and a property tax refund that was received in the second quarter last year, which did not repeat this year. Depreciation increased by $1.7 million to $6.2 million, largely due to our multi-year ERP implementation. This program will involve multiple asset in service or go live dates as we move forward into 2018. As we discussed last quarter, we’re in the process of moving several activities in our New York office to our corporate headquarters in Wisconsin. We’re also in the process of relocating the New York office to a smaller space, which will house a few key creative and public relations professionals. As a result, other operating expenses increased by $0.4 million, primarily due to the severance related to the downsizing of our New York offices. Operating income was $0.2 million compared to operating income of $2.7 million in the second quarter of 2016. Income tax benefit for the quarter was $1.6 million, and this compares to income tax benefit of $1 million in the same period last year. This results in a net loss for the quarter of $3.9 million or $0.12 per share, compared to a net loss of $2 million or $0.06 per share last year. In addition to the GAAP measures that we outlined above, adjusted EBITDA is an important profitability measure that we use to manage our business internally. For the quarter, adjusted EBITDA was $6.8 million, which compares to adjusted EBITDA of $7.3 million in the second quarter of last year. Now let’s take a look at the balance sheet. Total cash at the end of the quarter was $177 million, compared to $210.7 million last year. Inventory at the end of the quarter was $370 million, which was up $16 million compared to last year. This is partially due to the increases in the inventory associated with our Delta contract as well as improved in-stocks in both our basics and our strong performing swim product. If you’ll recall, we were constrained on inventory in last year’s second quarter, and our ability to flow inventory in a more timely basis helped drive improved sales in July and into August. In addition, we’ve made some investment in our inventory for the back half of the year with better timing of receipts for our fall and transitional product, which we expect will leave us in a strong inventory position and help drive our performance during the third quarter. Overall, we believe that the quality of our inventory has improved versus a year ago. Our quality is fresher, it’s more current with less aged product, and we remain very comfortable with the quality and content of our inventory investment. Net long-term debt decreased to $488.1 million, compared to $491.9 million at this time last year, with the reduction due to the quarterly principal payments. Cash provided by operations in the second quarter was $47.1 million as compared to operating cash flow of $52.1 million during the second quarter last year. We expect CapEx to be approximately $35 million to $45 million in 2017. The majority of this is associated with the ERP and other information technology investments. With that, we’re going to open up the call for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Alex Fuhrman of Craig-Hallum Group. Your line is now open.

Great. Thank you very much for taking my question. I wanted to ask a little bit about the growth in the customer file that you’re talking about. Presumably, this is what’s leading to the nice turnaround there in the U.S. e-commerce business. Can you give us a little bit of color on where that’s coming from and if you expect that to continue throughout the rest of the year and into next year?

Well, it’s coming from us making that strategic decision that we talked about a couple of times, Alex, to reallocate some of our marketing dollars over to working media. So we’re seeing those dollars become more and more productive there. And we’re – it’s certainly helping to drive the performance in the current quarter, I think an important thing is as our customer file builds, you’re going to continue to have that rebuy with a stronger customer base, and so that performance should help to continue into the back half of last year. We’re also planning to continue with that spend, focus on working media through the back half of this year, so we would anticipate continued momentum in our buyer file.

That’s great. So that means – do you feel then that, that you kind of turned the corner on the Direct business? I mean, you’ve obviously been declining for several years in a row. It sounds like the first quarter probably would have been up a little bit if not for the timing of some big orders. Comparisons start to get a little bit harder in the back half of the year. I mean, do you feel that with the momentum you have and the Delta business coming online, whether in Q4 or Q1, do you hope that sales in the Direct channel are going to be positive from here on out?

Well, without giving any direct items on what we anticipate, we certainly feel good about what we’ve done. And I think that, as we’ve said on prior calls, that strength in the buyer file should yield results going forward. And so we do feel like we’ve turned the corner. It’s still a very promotional environment out there, so we continue to have a little bit of headwind from our gross margin rate. But from a top line – from a units and from a top line sales, I think we’re feeling very good about where our Direct business stands.

Okay. Now that’s very helpful. And then just interested about your comment about certain openings standalone stores in 2018. Can you give us a little bit of a sense of how many you might be thinking of? And just in terms of real estate, I mean, it seems like the stores you have right now or have opened historically are incredibly varied, from small little trip centers to the pop-ups that you were doing in New York City. What might these look like from a cost and size standpoint? And then putting that all together, where, ballpark, do you think margins could start to shake out over the next year or two? Wasn’t that long ago that the business was doing a nice high single-digit operating margin? I mean, is that kind of something that you think can be done again in the next couple of years? Or just potentially, the movement to open stores maybe start to lay the groundwork for more long-term stuff, but perhaps you’ll weigh on that in the short term?

Alex, concerning the question about stores, we’re working on a strategic plan for that now. Working on a concept for the stores, depending on what we want the store to look like and also what type of technology is going to go into the stores. We’re kind of finalizing the plan throughout quarter three. We have a bunch of stores right now, about 11. And overall, we make money in those stores. But we didn’t really feel like it was a smooth customer experience. We didn’t feel that the concept was really right, so we’ve been putting together a real estate strategy, and we’ll probably open mid-single digits in stores next year in areas where we know that we have a very good customer base in order to test this out or to make sure that we have a good profit model before we move forward. And as we get the numbers pulled together probably by end of quarter three, we can share a little bit of that with you.

And I think on your question on margin, I wouldn’t see, certainly in the short term, I wouldn’t see retail having a significant impact on what the margins look like. As Jerome said, we’re just going to be opening a handful next year and then hopefully more in the following year. So I wouldn’t see a significant shift in our margin structure as a result of new store openings.

Okay, that’s really helpful. Thanks. And then just, yes, I guess, forgetting about the stores then, just trying to put everything together, gross margin and SG&A. I mean, it seems like the overall margins of the business have shrunk a lot over the last couple of years. I mean, how much do you think is reasonable? What is your goal? How much of that needs to be recovered over the next couple of years?

More so than a goal, I think what we said in my prepared remarks around some of the headwinds that we had from a margin perspective, we had some onetime things in this quarter that I think will normalize out. We had some increased shipping costs, we had the increases in net duty expenses, we had the FX impact, so some of those things will normalize out. We’re also in the middle of liquidating through some product. I think we’ll be through the vast majority of that here into the third quarter and definitely into the fourth quarter, so that should help to improve margins. I think what we’re doing underlying that, we’re being far more productive with what we’re doing, from a promotional offering, from a promotional cadence, and we’re starting to see the positive impact from that. And so I think as we go into the back half, we anticipate some stronger year-over-year margin performance, but we also certainly still anticipate being in this very highly promotional environment. So that will be our challenge.

I appreciate the comments. Thank you very much.

Thank you.

Thank you. And that is all the questions we have today. Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program, you may all disconnect. Everyone, have a great day.