Lands' End, Inc. (LE) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Lands’ End’s First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call maybe recorded. I would now like to turn the conference over to Bernie McCracken. You may begin.

Good morning and thank you for joining the Lands’ End earnings call for our first quarter fiscal 2018 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 President; 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 10-K and quarterly report 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 measures can be found on our earnings release issued earlier today, a copy of which is posted in the Investor Relations section of our website at landsend.com. With that, I will turn the call over to Jerome Griffith.

Thank you, Bernie, and thank you everyone for joining us today. We are very pleased to be starting off the year on a strong note. We delivered our fourth straight quarter of top line growth and third quarter of profitability growth demonstrating the continued progress we have made across our strategic initiatives. Sales in the first quarter grew by approximately 12% largely driven by the Delta Air Lines launch as well as our growth in our key product categories. We saw growth in our U.S. consumer business and double-digit sales increases in our international businesses. Adjusted EBITDA increased to $9 million from $1.3 million a year ago. When I joined Lands’ End last year, our first priority was to get back to the classic American Heritage and embrace the innovation that made Lands’ End a great brand. We are accomplishing this through the execution of a number of strategic initiatives that are focused on four key areas: product, digitization, distribution, and infrastructure. In 2018, as we continue to make advances in these key areas, we will also increase the level of collaboration between them. Before providing an update on our strategic initiatives, I would like to call out some highlights from the quarter. First, our product continued to receive favorable response as we presented an assortment that offers quality, value, and relevance to our consumer. Strength in the business was driven by our swimwear products, particularly those styles that offer sun protection as well as increased sales of our knit-tops and bottoms categories. Second, we continued to build our customer file, driven by a double-digit increase in buyers who have purchased in consecutive years. Within our new customer segment, we are extremely pleased that they are purchasing our key items and re-buying at a higher rate than last year. Importantly, we are also attracting new buyers from all age groups and they are skewing somewhat younger than our existing customer mix, which tells us that our products are appealing to a broader consumer base. Third, we saw an increase in conversion rate during the quarter due to our strong product offering and marketing efforts driving high-quality traffic and through improvements in our overall customer experience. In our retail segment, we are well underway with the rollout of new retail locations and we are pleased with the early results of our new concept. We opened two new company operated stores during the quarter, the first is outside Chicago in Kildeer, Illinois and the second is outside Boston in Burlington, Massachusetts. The stores integrate improved technology into the shopping experience with a kiosk available if the customer is interested in our expanded online offerings. While our comp store sales were challenged in the first quarter, we attribute much of this decline to the performance of the Lands’ End shops at Sears as well as the impact of the extreme weather in February and March, which we believe impacted in-store shopping. We saw retail sales trends improve in the back half of April and further improvement in May. Overall, we remain confident that we are headed on the right path in terms of our retail strategy. Looking ahead, advanced data analytics will remain a driving force behind everything we do as a customer-centric organization. Within product, we continued to leverage data to drive better intelligence on pricing and inventory with a focus on our core categories of outerwear, swimwear, knit-tops, and bottoms as well as seasonal fashion items that makes sense for our customer. Our efforts to hone in on key items within these categories have been highly successful driving growth in our customer file as well as an increase in our conversion rate. Taking this to another level based on our data analysis, we are learning what fabrics, silhouettes, and price points are driving purchasing behavior and using this information to design new styles in popular fabrics, develop top selling silhouettes and additional fabrications, and deliver product in the price points where there is the greatest perceived value. For example, based on customer data, we know newness is most effective when we insert fashion elements such as print, pattern, or embellishment into a key item like our women’s Supima cotton sweater. We also see success when we add a feature that the customer appreciates, a product with a purpose such as stretch in our men’s favorite chinos or reinforced knees for kids’ pants. By leveraging our data to provide more of the product that our customer wants, we believe we have an opportunity to increase purchasing activity from active buyers and attract new buyers. As Jim will discuss, we have also taken steps to significantly improve our inventory mix, particularly in the U.S. direct business. This, combined with tighter inventory control, is enabling us to enhance inventory effectiveness within certain areas of the assortment, so that we can more quickly bring in fresh product at the start of each season and be more strategic with our promotions. We also remain relentless in our efforts to continually improve the customer experience. We are focusing on using our digital capabilities to reach the customer in highly personalized ways, including product searches both on our site as well as third-party search. Part of this effort is improving both our product page and the search functionality to best capture the customer during the discovery phase. We are enhancing our site with best-in-class search engine optimization practices, including updated product descriptions that align with the language and search habits that our customers use when searching for products. For example, we want to ensure that if she is shopping for tankinis, she can quickly and easily find the swimsuit that fits her wherever she chooses to engage with our brands. We believe this will ultimately translate into more traffic with relevant results and higher conversion for both new and existing customers. In addition, we are using our data analytics to personalize the customer experience. We have a data-driven strategic view of what the personalization journey will look like for Lands’ End as we leverage both online and offline customer behavior to connect customers with the right products at the right time in the right contest. This means that the products that we highlight on our site or on e-mail communications for one customer maybe different than what we may highlight for their best friend, as we know their purchasing behaviors are not the same. Our initial work with personalization has helped deliver an increase in our conversion rate during the first quarter, which gives us confidence that our data-driven recommendations are on point with our customers’ needs. In addition, we are focusing on evolving our sourcing strategy, enhancing our partnerships with existing vendors, and working with new vendors where it makes sense, particularly on our key programs. This will enable us to enhance fabric quality, increase speed to market, and elevate product development. We plan to leverage these product improvements through a refined marketing strategy, more strategically honing in on the products and promotions that drive purchases. In terms of our distribution strategy, we are focused on developing a uni-channel approach, ensuring that customers have the same great experience where they purchased our products, no matter where or how they choose to shop and make that purchase. And through the new stores we have opened and planned to open, we are also making it easier for customers to find our products in person, and in an inviting brand appropriate setting. As I mentioned, while we are making it easier than ever to shop through our own website, landsend.com, we have recognized that half of apparel searches now start on Amazon. So, we are working with Amazon to provide another channel for consumers to discover our products. Based on our early results, we see that over half of our Amazon customers are completely new to our brand, and we are thrilled to see that this new customer is buying the same key items our existing customers love. Based on this early success, we are exploring the use of marketplace and other third-party e-commerce in Europe and Asia to expand our brand globally. We are in very early stages of this exploration and we will provide updates after we take more definitive steps. Turning to our Lands’ End Outfitters business, we saw strong growth during the quarter driven by the Delta Air Lines business. Delta requires 64,000 of its employees to be in uniform on May 29 and I am so proud of our employees for executing this large program flawlessly. We believe that the experience, exposure and credibility we gain from such a large visible program, positions us to compete for and attract similar opportunities. For example, we are in the planning stages for the American Airlines uniform business we were awarded in January and expect the launch of that program to come in the second half of 2019. Our school uniform business has also gained momentum as we began working with a number of new accounts and have a very solid pipeline of potential accounts going forward. Finally, we continue to work on improving our processes and enhancing our infrastructure to support the initiatives that we are undertaking throughout the business to drive our long-term growth. We recently launched the direct procurement and financial planning modules of our new ERP system and the rollout has gone smoothly so far. We expect that we will be substantially complete with their ERP implementation by the end of 2018. The next phase of our technology investment and upgrade will be in enterprise order management system that will enable inventory optimization and more flexible fulfillment options. We have started the initial planning work for this project in preparation for a phased implementation of this new system beginning in fiscal 2019. In summary, we remain focused on executing our strategic initiatives, leveraging our data to further define our product assortment, become an even more digitally-driven company and improve our distribution network. At the same time, we will continue to enhance our infrastructure to support the business and help us achieve our long-term objectives. Our effort will be routed in responding to what our customers are telling us by offering the products they want communicating to them in a personalized way and making it easier for them to shop with Lands’ End as we move toward becoming a uni-channel retailer. We remain pleased with the progress we are making throughout the business. And as we continue on this journey to evolve the Lands’ End, we believe that we remained well-positioned to meet our long-term goals. With that, I will turn it over to Jim to review our financial results in more detail.

Good morning, everyone. As Jerome mentioned, we are pleased with the strong start to fiscal 2018 with double-digit revenue and significant adjusted EBITDA growth in the first quarter. For the quarter, revenue increased 11.7% to $299.8 million compared to $268.4 million last year. Sales in our direct segment grew 19.7% to $273.4 million and retail sales decreased 34% to $26.5 million. Excluding Delta and adjusting for closed Sears stores, total revenue increased 3.4% with the direct segment growing 6.5% partially offset by retail decreasing 18%. In terms of product, consumers continue to respond well to key items within their core categories. During the first quarter, growth was led by a strong swimwear business, specifically beach living in addition to our knits and our bottoms. As Jerome mentioned, we continue to see improvement in our buyer file metrics and are especially pleased in the momentum with our active buyers as our enhanced product assortment and targeted marketing efforts are driving improved loyalty and increasing repeat purchases. Within the direct segment, we saw strong growth in our Lands’ End outfitter business driven by the launch of Delta. As part of the launch, all personnel were required to be in uniform by May 29. We had shipped approximately 75% of the launch orders through the end of the first quarter which was comprised of approximately 25% shipped in the fourth quarter of 2017 and approximately 50% shipped in the first quarter of 2018. We expect to ship the remainder of the orders approximately 25% in the second quarter, which will essentially conclude the national launch. After the initial shipping period ends in the second quarter, we expect to see minimal revenue from Delta until the second quarter of 2019. We are also working closely with Delta to expand our product offering beyond the standard kits that we provided at launch and expect to debut these products during 2018. In addition to our Delta business, we are finalizing the launch of American Airlines. We currently expect this launch to take place in the fourth quarter of 2019 and we will update on timing as we approach the date. Turning to our retail business, we had a disappointing start to the year with our Lands’ End shops at Sears and a lesser extent our company operated stores both declining. Our same-store sales decreased 18.9% for the quarter. Our performance was negatively impacted by weather events in February and March. However, we did see our retail sales trend, primarily in our company-operated stores begin to improve in April and that continued into May. Same-store sales for our company-operated, was also negatively impacted by a reduction in unprofitable clearance sales. The company is very focused on higher sell-through of our in-season product to reduce unproductive sales and improved gross margins. During the first quarter, we had 46 fewer Sears locations compared to last year and ended the quarter with 159 shops at Sears. As of quarter end, there were an additional 11 shops that were in the closing process and we have been notified since quarter end of an additional 16 shops that will also close in the third quarter. Therefore, we expect to end the third quarter with no more than 132 shops at Sears. Approximately half of which have leases that expire at year end. We also ended the quarter with 14 company-operated stores. We recently opened 2 new stores, the first in Kildeer, Illinois, that was on April 30 and the second in Burlington, Massachusetts on May 14. We are planning to open 3 to 4 additional stores during the year as we continue to test and expand our customer-focused unichannel strategy. Gross margin decreased approximately 130 basis points from last year to 44.4% and gross profit increased $10.4 million or 8.5% to $133 million. The direct segment gross margin decreased approximately 210 basis points to 45%. The gross margin contraction was primarily related to the launch of the lower margin Delta business and to a lesser extent a higher mix of promotional sales partially offset by improved aged inventory management. In the retail segment, gross margin increased approximately 40 basis points to 37.8% driven by our company-operated stores partially offset by lower margin in our shops at Sears. Company-operated stores improved mainly due to more effective inventory management of our seasonal assortment, which led to a reduction in unprofitable clearance sales. As we look ahead to the second quarter, we expect the remainder of the Delta launch as well as the continued highly promotional environment to remain headwinds for gross margin. However, we do expect margins will sequentially improve in the back half of this year and stabilize next year as we improve our promotional productivity and improve our initial margins through sourcing initiatives which should begin to yield benefits in 2019. Selling and administrative expenses increased $2.7 million to $124 million. SG&A as a percentage of revenue was down approximately 380 basis points due to continued expense management, driving improved leverage of marketing and personnel cost partially offset by higher incentive accruals. Operating income was $2.5 million compared to an operating loss of $6.7 million in the first quarter of 2017. Our effective tax rate was a negative 68.1% in the quarter, which compares to a negative 35.2% in last year’s first quarter. The tax benefit is principally the result of a favorable state tax audit settlement for prior periods combined with the recent tax reform. As a result of this favorable audit, we expect the tax rate to be approximately 15% for the year. Net loss for the quarter was $2.6 million or $0.08 per share compared to a net loss of $7.8 million or $0.24 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 $9 million, that’s a $7.7 million increase compared to $1.3 million last year. Now, let’s take a look at the balance sheet. Total cash at the end of the quarter was $141.6 million compared to $139.8 million last year. Our $19 million improvement in operating cash flows was a direct result of the better sell-through of seasonal inventory, combined with continued progress on reducing lead times to improve inventory flow. Inventories at the end of the quarter, was $304.5 million, which is down $5.4 million compared to last year. We continue to be pleased with not only the level, but the improved overall health of our inventory. Net long-term debt decreased to $485.3 million compared to $489.1 million at this time last year with the reduction due to quarterly principal payments. And finally, looking ahead, we continue to expect CapEx to be approximately $35 million to $45 million in 2018 largely due to investments in our ERP implementation and the initial investment in our new order management system. Overall, I believe the investments we are making in our infrastructure will both support our strategic initiatives and help us to achieve our long-term financial targets. With that, we will open up the call for questions.

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

Great. Thank you very much for taking my question and congratulations on a really nice quarter here. I would love to get a little bit more color on the new stores that have just been opened, how you are feeling about the initial productivity about that? Is there any consistent feedback you have been getting from the employees there or the customers and just any change in your thinking now that you have got a couple out there as far as how you want to approach that strategy over the next few years?

Thanks, Alex. Yes, no real change in strategy, at this point, we only have a couple of stores opened. The first one was Kildeer, which is in the new store concept and that’s right outside of Chicago. We are very pleased with what the early results are looking like, productivity is very much higher than what our existing stores are. We have a very small assortment in the store. We are carrying women’s swimwear and men’s that seems to be working relatively well for us. We have the availability to buy anything online in the store that you don’t see in the store that also seems to be working well for us. The way that we set the store up where it is in an open air shopping center, very convenient just to drive up, we have got a lot of good competitors in the area. We are near a Whole Foods, we are down the street from Apple, The Gap, it’s coming out great, and we are really pleased with it, but it’s kind of what we expected. We thought it would be a very productive store. We thought we will be doing very well with it. And so far I would say we are on track. We opened up a temp store in Burlington, Massachusetts and that was in response to one of our largest Sears locations closing, they had a store in Burlington and we opened up right outside where that store was. That’s still early days, but that’s going well as well. And we have got 3 or 4 more stores opening up towards the back part of the year, which we are looking forward to, but we think that we will be right on track to be where we said we would be in opening up our own stores and having them be part of our distribution strategy.

Great. That’s really helpful. Thank you. And then wanted to ask also just about the uniforms business, it sounds like the launch of the new uniforms at Delta went really well and had a nice impact here. On the quarter, just trying to understand a little bit about what the business might look like in a few years if uniforms continues to grow. It sounds like you have potentially a few other big accounts that could be added over the next year or two like Delta, and I think you mentioned just the lower gross margin for that business and how it impacted the quarter. Can you give us a sense of – if uniforms were to be growing double-digits for a couple of years, really become a bigger chunk of the business, what does that do to the overall margins? I mean, is it fair to assume that there is less marketing and SG&A associated with that business? Is it a similar EBITDA margin as your regular e-commerce business?

Yes, what we have said before Alex is the gross margins are lower, but the overall profitability is either at or slightly better than the average. Yes, you can see the benefit in what we gave you with the margin rate deterioration in the first quarter that the largest chunk of that was Delta. And just to correct a little bit, you probably misspoke, but what’s coming in next year of course is American Airlines, so we have Delta that will be through the launch. We don’t anticipate much business coming from Delta for the next year that’s when their employees will get another allocation. So the rest of this year will either be turnover or some of the Delta’s replacing -- current Delta employees replacing things that they already purchased, and then American Airlines should launch sometime towards the end of next year.

Great. That’s really helpful.

Thank you. Our next question comes from the line of Steve Marotta of C.L. King & Associates. Your line is open.

Good morning, Jerome and Jim. Congratulations on the first quarter. Jerome, a specific question about other income, was there a reclassification in the quarter which pulled a little bit out of SG&A into other income?

I think that’s a tax reclassification in there, Steve.

Okay. Is that a permanent reclassification or that was one-time?

Sure. And that’s also a write-down of receivable, that’s a one-time.

Okay, so all those were one-time in nature, okay. So they would not affect – that wouldn’t materially affect your long-term EBITDA percentages?

No.

That’s fair enough. From an Amazon standpoint, can you talk a little bit about your ability to see and market to those customers in the future?

Sure. We have only been with them in a meaningful way I think for about 3 months, 3.5 months right now. Results look great. We are extremely pleased with them. What’s interesting to us is as we are marketing online and this is no new news to you more than half of clothing searches online start in Amazon, and we have a small marketing program with them and seems to be going well. What’s interesting for us is that customer mix and what we are selling, we are selling our key items, so we have a big swimwear business globally, we have a great swimwear business at Amazon, we have a good bottoms business globally, we have a good bottoms business at Amazon. And the customers that are coming in are their new customers, so more than half of them have never shopped at Lands’ End, and a good 30% of them have been long-term lapsed customers, meaning they haven’t been a Lands’ End customer for well over a year. So, we are extremely pleased with the early results there and we think that our marketing efforts on Amazon are bearing fruit, and we are excited to see what happens with this going through the holiday season and into next year.

So the question is if Joe Smith from somewhere in the Midwest buys something on Amazon, you had never known Joe Smith, but you now have their information to send them a catalog for instance or to speak to them directly, is that accurate?

We are not fulfilling directly from our warehouse here at this point in time with the systems that we have available. We are fulfilling from Amazon. So Amazon is sending directly to them.

Okay, fair enough. And when you are talking about European growth, do you have a similar relationship or want a similar relationship with Amazon in Europe or are there other players that you could – other platforms you could potentially be on there?

We are exploring that at this point in time. The answer to that question would be yes and yes, we will be working with Amazon internationally and we plan to work with them internationally. And there are other players and big players in individual markets that we are in talks with as to how we can get product feeds to them and start to market on their websites. I think that’s – it’s a big opportunity for us. It’s early days, we are not used to selling through somebody else’s market size, but it’s something that we could do a much better job with. We have a very small business right now in England with one of the department stores there, Debenhams, I don’t know if you are familiar with it, but we do marketplace marketing online with them and we have a relatively robust business with them.

One more question, just as a reminder, as a percent of your direct sales, international is roughly 20% correct?

Yes. I think we have given that number before. That’s an approximate number, yes.

Thank you very much.

Thank you. And that does conclude the Q&A session 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.