Lands' End, Inc. (LE) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Lands’ End’s Second Quarter 2018 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 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 second 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 on 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're very pleased with the progress we have made across our strategic initiatives during the second quarter. The work we have done is evidenced by our performance. We delivered our fifth straight quarter of top line growth with sales in the second quarter growing by approximately 2%. We saw strong start to the quarter in May. However, as Jim will discuss shortly sales in July slowed as we did not have adequate seasonal inventory to meet demand. We're also pleased to see stabilization in our gross margin rate with both the U.S. direct and retail businesses as a result of strong sell through, and we recorded our fourth straight quarter of profitability growth with adjusted EBITDA increasing 13%. Our products with purpose continue to resonate with our customers as we emphasize newness while maintaining our focus in quality, value, and comfort. As we've stated before, over the last several quarters, all of our efforts to improve and grow have been grounded in data analytics. As it relates to our product assortment, by leveraging this data, we're able to align our offering with what our customers want. The progress we are making is illustrated by continued strength in our conversion rates which were up in the high-single digits in the second quarter. We saw our strongest sell through in beach-living tankinis, chino shorts, cover ups, and knit sleeveless dresses. Our early reads on our fall product have been strong due in part to the positive response to the newness we've injected into our assortment. In particular, we're very pleased with the early results on our denim launch. We believe that we have an opportunity to win this category with our expertise in fit combined with our ability to strike the right balance between quality and value. This year we also made a bigger push into early fall outerwear with transitional silhouettes and fleece and an expanded ultralight down assortment. Last quarter, we talked about further utilizing data analysis to determine what fabrics, silhouettes, and price points are driving purchasing behavior and using this information to design new styles and popular fabrics. These product line extensions are a great example of putting this strategy to work. In terms of marketing we have been leveraging our data to begin testing segmentation. In the second quarter we continued to optimize our e-mails with personalization. We're focusing on best selling items to deepen our engagement with customers and tailoring our message to garner the best response from each individual customer. Early results are positive with double-digit increases in conversion year-over-year. We plan to ramp this effort up over the second half of the year. Additionally, we once again saw a growth in our customer file. This was on top of a double-digit increase last year which we attribute to both improvements in our product and more effective marketing strategies. During the second quarter we executed the Delta Air Lines uniform launch. The project was an ambitious one with our client requiring all above and below wing personnel, 64,000 strong in uniforms simultaneously for May 29th global launch. As the uniforms were rolled out across the globe, starting with a flight out of Singapore and concluding in Los Angeles, Lands' End was with Delta at every step and the program has been a great success. As we look ahead, we will continue to focus on our four key areas to drive sales and profitability over the long-term. These are focus on product, be digitally driven, be a uni-channel distributor, and improve our infrastructure and processes. First is our focus on product. Product remains our number one priority. We're committed to exceeding the expectations of our customers who want clothing that's comfortable and functional, serves a need within their wardrobe and fits into their relaxed lifestyle. We maintain our emphasis on core categories of outerwear, swimwear, knit tops, and bottoms supplemented by seasonal items. In addition, we continue to leverage our data analytics to inform styles and silhouettes with compelling value to drive increased purchases. Earlier, I mentioned two examples in our extended fleece and ultralightweight down offerings. Another example is the introduction of our curvy fit jeans, a combination of a new fit and stretch fabric to deliver a product that meets the needs of the customer. These product extensions help us to maintain newness in categories that our customers seek from Lands' End. In terms of our classic styles, we want to continue to offer customers more of what they love while also ensuring we provide them with newness in terms of prints, colors, patterns, and embellishments. Our women's no fade deep black jeans stands up to 50 washes and are a great example of where we can do this to drive excitement in a core category. For men, we introduced our comfort first jeans made of a ring spun cotton but with a hint of stretch resulting in durable comfortable fit. Second, we are digitally driven as we work to leverage the wealth of information we have from our catalog heritage and deepen our engagement with customers through personalization. For example in July and August we delivered more relevant experiences in e-mail and our website with households with kids receiving back-to-school messaging while other adults were served transitional and fall product offerings. We continue to develop insights into the product offerings and marketing campaigns that drive customer response. By using this information to determine individualized messaging in our e-mails and customer specific content on our page views, we believe we can drive higher conversion. As we look toward holiday, we plan to have relevant and differentiated communications for gift givers versus customers that purchase for themselves based on behavioral data signals. As we develop a uni-channel distribution model, we continue to focus on creating a consistent high quality seamless customer experience across channels to enhance our customer connection wherever and however they choose to shop. We plan to do this through our own retail store expansion, our own website, landsend.com and third party e-commerce platforms like Amazon. Beginning with our retail expansion we remain committed to developing our own retail footprint. Our new stores make it easier for customers to find our products in person in an inviting brand appropriate setting. New stores should also drive greater brand awareness. During the quarter, we operated our new store in Kildeer, Illinois, which opened during the last week of Q1, and our new store in Burlington, Massachusetts which opened early in Q2. We're learning a lot about customer preferences, and we're using that data to test which products from our whole assortment are best represented in-store versus available through in-store electronic kiosks. Our company operated stores performed better than the Lands' End shops at Sears, and we expect performance to improve as more customers discover our attractive, well-merchandised locations. As you know, we had a goal of opening four to six stores this year. Already in the third quarter, we've opened two additional stores, one in Staten Island the other in Bridgewater, New Jersey. We plan to open one more in Paramus New Jersey by year end, which would bring our new store openings this year to five. On landsend.com we are continuing our shift towards becoming a digitally-led business through enhancements to our website experience across all platforms. We're focusing on improving both our product page and 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 match the language and search habits that our customers use. We're also beginning to understand how our best customers engage with both our digital and contact center channels. They desire an easy experience how and whenever they choose to engage with Lands' End and we're working to improve our online self-service capabilities in time for the holiday shopping season. Increasingly our core customer is visiting and purchasing from us on a Smartphone and we're very pleased that in spite of the major traffic shift to the Smartphone which is typically a lower converting device, we're seeing double-digit increases in online conversion year-to-date. As you know we began selling key items on Amazon in February. While it's still early we're seeing evidence that we are reaching new customers and increasing brand awareness. Approximately three quarters of all customers who purchase Lands' End through Amazon are either new to the brand or haven't shopped at Lands' End in the last year. We believe Amazon could provide tremendous potential for us to expand our customer reach. WE'RE also excited to see we're attracting a younger customer through Amazon and that we can sell our products in a less promotional way. We were very happy to participate in Prime Day as we were featured in several deals of the day and more than quadrupled our average daily sales. Finally as we've been discussing before 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 are focused on completing our ERP system implementation by year end and are launching our enterprise order management system project. In summary we remain pleased with the progress we're making throughout the business. We remain focused on executing our strategic initiatives and believe we are well positioned to meet our long-term goals. With that I'm going to turn it over to Jim to review our business and financial results in more detail.

Good morning everyone. Overall we're pleased to see the growth in our direct business in addition to the stabilization of our gross margin as we execute against our strategic initiatives. For the second quarter revenue increased 1.9% to 307.9 million compared to 302.2 million in the same period last year. Sales in our direct segment grew 6.4% to 276.6 million while retail sales decreased 25.8% to 31.3 million. As Jerome stated consumers continue to respond well to key items within our core categories. However, our efforts to tightly manage inventory left us short on critical end of season merchandise. Specifically items in beach living, chino shorts, mid cover ups, and kids swimwear. We put substantial effort behind inventory discipline and even though we made tremendous progress in this area we believe we overcorrected in terms of our [indiscernible] merchandize which left us short on end season sale product in the latter part of the quarter. While our decision to reduce meltdowns did have a positive impact on merchandized margins, it had a negative impact on overall sales and specifically did not allow us to capture additional profitable meltdowns sales at the end of the season. That said the quality of our inventory continues to improve with another significant reduction in aged inventories which then -- instilling a test and learn culture across all facets of the organization and rather than just buy more. We will apply what we learn in order to buy smarter. As a result we have already adjusted inventory buys for the second half to ensure we had the right level of end season markdowns and we will be well positioned in terms of our product mix and quantity for fall and holiday. Within the direct segment we continue to see strong growth in our Lands’ End outfitter business led by Delta Airlines as all personnel were required to be in uniform by May 29th. Given that this completed the initial weighted up employee orders we expect to see minimal incremental revenue from Delta until 2019. Overall the launch was highly successful and we believe this fuels future opportunities for us to win additional corporate contracts. Turning to our American Airlines launch we are initiating our road testing in preparation to outfit 51,000 airline employees primarily flight and customer service personnel and continue to expect this launch to take place in the fourth quarter of 2019. We will keep you updated on timing as the date approaches. Looking at our retail business results at our Lands' End shops at Sears were down significantly while our company operated stores were fairly flat to last year. Overall our same store sales decreased 5.8% for the quarter with Lands' End shops at Sears declining 6.7 and our company operated stores down less than 1%. While our retail sales primarily in our company operated stores improved in May and June, performance softened in July primarily due to the reduced levels of end season markdown merchandise that I discussed earlier. During the second quarter we had 57 fewer Sears locations compared to last year and ended the quarter with 147 shops at Sears. Currently there are an additional 38 shops that are in the closing process or have recently been announced to close before Thanksgiving. Therefore, we expect to begin the holiday with no more than 109 shops at Sears approximately half of which have leases that expire at year-end. We also ended the quarter with 15 company operated stores. In early August we opened Staten Island, New York and in late August opened Bridgewater, New Jersey. We plan to open one additional store in Paramus, New Jersey during the year as we continue to test and expand our customer focused unichannel strategy. Gross margin was up slightly at 44.4% and gross profit dollars increased 2.6 million or 1.9% to 136.8 million. But direct segment gross margin increased approximately 10 basis points to 44.2%. Gross margin expansion was primarily related to higher full-price selling driven by the reduction of end -of-season markdown sales, partially offset by the launch of lower margin Delta business. In the retail segment gross margin increased approximately 30 basis points to 45.7% mainly due to tight inventory management of our seasonal assortment which led to a reduction in markdown sales. As we look ahead to the second half, we continue to expect margins to sequentially improve as we drive promotional productivity, manage our late season markdowns, and execute sourcing initiatives to increase initial markups. Selling and administrative expenses increased 1.7 million to 129 million. SG&A as a percentage of revenue was down 20 basis points due to continued expense management driving improved leverage at marketing and personnel costs, partially offset by higher incentive accruals. Our effective tax rate was 7.5% in the quarter which compares to 29.4% in last year's second quarter. The tax benefit is at lower effective rate than prior year due to a tax reform in certain foreign entities. As a result of these losses and prior period actions, we expect the tax rate to be approximately 15% for the year. Net loss for the quarter was 5.3 million or $0.16 per share compared to a net loss of 3.9 million or $0.12 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 7.7 million, that's a 13.1% increase compared to 6.8 million last year. Turning to the balance sheet, total cash at the end of the quarter was 194.4 million compared to 177 million last year. Our 17.4 million improvement in operating cash flows was a direct result of tighter management of seasonal inventory and continued progress in reducing the lead times to improve inventory flow, partially offset by inventory to support the Delta Air Lines business. Inventories at the end of the quarter were 349.6 million, down 20.9 million or 5.6% compared to the end of second quarter last year. We continue to be pleased with not only the level but the overall health of our inventory. Net long-term debt decreased to 484.4 million compared to 488.2 million at this time last year with a reduction due to the quarterly principal payments. And finally, looking ahead we 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 goals. With that, we will open up the call for questions.

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

Great, thank you for taking my question. Appreciate the commentary about the seasonal product and your inventory levels there. I'm curious what you're planning for the fall and holiday season in terms of inventory levels for outerwear and your seasonal categories there, are you expecting to see similarly strong demand in the seasonal categories for the winter items this year?

Good morning Alex. Well, I think as I said I think we're taking learnings out of this last quarter. We think we bought too tight. It definitely had a positive impact on our cash flow and a positive impact on our lower inventory balance, but we went a little bit too far, so we certainly are making those adjustments and are going to buy a little bit deeper for fall and holiday.

That's helpful, thanks. And then can you talk a little bit about the stores that you've been opening. You know is it effectively the same merchandise assortment as you are seeing on landsend.com, is there anything that customers, in particular, have been gravitating towards and do you get a sense that there's a different mix perhaps of new versus existing customers in those stores versus your online business?

It's still early days Alex, but what we have seen so far is that best sellers online are best sellers in stores. Things that are key items online that do extremely well there also do well in stores. We do see, because the stores are a tighter footprint, and we don't carry everything in our full range in our stores that we have a little bit higher penetration with our kiosk sales. So customers will come in and they may want something that's not in the store or maybe we don't have the size, and they buy it online, and that penetration has been increasing a lot more with newer stores than with some of the existing stores that we've had.

That's helpful, thank you very much.

Thank you and I'm showing no further questions at this time.

Okay, then thank you very much.