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dELiA*s, Inc. (NASDAQ:DLIA)

Q4 2013 Earnings Conference Call

March 20, 2014 4:30 p.m. ET

Executives

Ryan Schreiber - SVP, General Counsel & Secretary

Tracy Gardner - CEO & Director

Lex Gemas - COO

David Dick - CFO, SVP & Treasurer

Analysts

Justin Ruiss - Sidoti

Brian Gaines - Springhouse Capital

Joe Yurman - 1221 Capital Management

Lee Cooperman - Omega Advisors

Operator

Good afternoon, ladies and gentlemen, and welcome to dELiA*s, Inc. Fourth Quarter 2013 Conference Call. At this time, all participants are in a listen-only mode. Later, we will open the lines up to conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

As a reminder, ladies and gentlemen, this conference call is being recorded on March 20, 2014, and may not be reproduced in whole or in part without permission from the company. Today's conference call will be available for replay beginning at 1 p.m. tomorrow through 11:59 p.m. April 20, 2014, on dial-in number (877) 870-5176, domestic, or (858) 384-5517, international, passcode 7376702.

I would now like to introduce Ryan Schreiber, Senior Vice President, General Counsel and Secretary of dELiA*s. Mr. Schreiber, please proceed.

Ryan Schreiber

Thank you, Vicki. Good afternoon, ladies and gentlemen. If you need a copy of our fourth quarter press release it is available on our Web site, deliasinc.com.

Before we continue, let me remind you that our statements today regarding the company's future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Private Securities Litigation Reform Act of 1995. These forward-looking statements, which can be identified by the use of the words believe, expect, should, estimate, plan, project, anticipate or similar expressions, are based on management's current knowledge and assumptions about future events.

Forward-looking information and statements involve risks, assumptions and uncertainties that could cause actual results to differ materially from our expectations as a result of many factors, including those contained in our annual report on Form 10-K, as well as in our subsequent filings with the SEC. These filings are available on both the SEC and dELiA*s Web sites.

All forward-looking information and statements are made as of the date of this call, and we disclaim any intent or obligation to update them. As a reminder, this call is being recorded on March 20, 2014.

At this point, I would like to introduce our Chief Executive Officer, Tracy Gardner.

Tracy Gardner

Thank you, Ryan, and thank you everyone on the call for joining you this afternoon. Joining me today are Lex Gemas, our Chief Operating Officer; and David Dick, our Chief Financial Officer. While we are not pleased with our fourth quarter financial results, let's remember we are in the early stages of a turnaround in difficult teen environment.

We are pleased with the meaningful progress and key initiatives that we believe will enable us to successfully drive our business forward. We are building upon the positive signs of our business today as we steward the repositioning of the dELiA*s brands. Like many in the teen space, we battle an intensively competitive and promotional environment with declining traffic trends. But below the service of our results, there was a significant amount of progress needs towards transitioning our company into a customer-centric, girls-only teen brand that enables her to express her individual style.

We saw encouraging response for our new spring merchandise that delivered toward the end of the fourth quarter. In the product categories, our new team was able to impact resonated with our customer in a much more meaningful way. While small wins thus far, we strongly believe that the steps we are taking to rejuvenate and differentiate our brands are putting dELiA*s on a new and stronger path to growth.

Our efforts to reduce non-productive legacy inventory in a highly promotional environment resulted in our significant gross margin declines, however, we effectively reduced inventory levels by 25% as compared to last year. And heading into the quarter, we improved our full price inventory position with nearly 60% of our inventory representing newly developed product.

Our team is acutely aware of our financial position and business performance. We took action in the fourth quarter to address our SG&A and overhead costs with a thorough line-by-line review of our expenses. We reduced our overhead costs by 15% in the fourth quarter as compared to the same period last year for a management-led restructuring effort. We expect this work to translate to approximately 5 million in annualized cost savings.

Our strengthened capital structure with the recently announced private placement offer should provide the support necessary to execute on our longer term plans. We strongly believe that our strategy is the right one to stabilize and turnaround dELiA*s, driving long-term value for our shareholders. And we are more committed than ever in executing our key initiatives and bringing dELiA*s to a leading position with our teen girl.

We have fresh product that is unique to dELiA*s, an established omni-channel platform, a growing social connection with our customers, and improved processes to support our long-term objectives.

In the last earnings call, we laid out a few strategic areas. I would like to speak to those now. First, our team. As we have mentioned, at the end of third quarter we assembled a world-class management team, which consists of some of the best talent from across the industry. We have strong leadership across product development, merchandising, marketing, and operations. We've complemented this leadership team with some amazing people to help execute our strategic plan. Our team's collective efforts are becoming increasingly apparent as we move through the first quarter of 2014, and we will build sequentially throughout the balance of the year.

Second, our product. We continue to transition our product to create an on-trend lifestyle assortment that enables our girls to express herself through fashion. In the fourth quarter, we saw positive reactions in categories that we were able to impact, sweaters, long-sleeve knits, knit bottoms and cold weather accessories all outperformed the balance of the assortment over December and January.

We also saw our girls continue to respond to our new and proprietary denim fits, Liv and Jayden. While new product represents just a small percentage of our overall assortment in the fourth quarter, we were highly encouraged by the excitement it created. We are building upon these successes as our product team remains focused on building our key franchise categories including graphic tees, dresses and new fits and washes in denim and pants.

We are developing an assortment that appeals to her individual fashion trends as well as her desire for great value. Our strategy to create unique product with dELiA*s edge is taking hold. With that said, it will take time for our assortment to fully reflect the vision of our new team and even then it will evolve as we continue to learn from our customer.

We also continue to form collaborations with favorite brands like Keds and Converse, and those relationships will continue to grow. We look forward to launching some new and exciting collaboration for back-to-school. Also, as part of our product strategy, we are positioning ourselves to get faster reads on performance and react quickly to changing trends. We have narrowed the number of suppliers and are focused on establishing strong relationship with fewer partners in order to achieve speed to market and better leverage our buying power.

In addition, we are platforming fabric and leaving open-to-buy dollars available to chase trends. We will focus on increasing efficiencies in our supply chain in order to achieve more flexibility in our product offering, as well as enhance our value proposition.

We also made good progress on the management to our inventory through a more efficient product investment strategy, and we are now looking at our business holistically across stores and direct. We have put greater discipline in place across both channels and have increased our visibility around inventory performance, all of which we believe can create higher quality sales with less inventory.

We reduced the number of SKUs we carry and intensified our allocation process. As I highlighted earlier, by the end of the quarter we brought inventories into higher quality full price position with product developed by our new team representing nearly 60% of our inventory. By the beginning of the third quarter, 100% of the merchandise assortment will reflect the work of our product team.

Third, our brand. We are focused on creating a more engaged relationship with our customer in driving more traffic, the teen customers shopping in a different way than ever before. We are connecting with her through our stores, our Web site, our catalog and social media. Today, her primary resource for discovering inspiration is social media. In the fourth quarter we tested the key tenets of our new social media strategy, and the results were extremely encouraging. We have many exciting initiatives on the horizon across social media, web and our stores, that we believe will create excitement and help you drive traffic and conversion.

We are partnering with brand ambassadors that love dELiA*s and want to share their passion for our merchandise with their followers. Our customers live and breathe all things digital, so must dELiA*s. We are working faster than ever to better connect with her.

We are making progress in bringing a unified and relevant brand image across our stores, Web site, catalog and social media. In January, for the first time we offered a key product message focused on denim and graphic tees, it was clear and strong across our windows, Web site, catalog and other digital assets. This aligned approach and consistent messaging across our brand channels will continue into spring.

We continue to enhance our stores to create a more dynamic shopping environment with an improved store layout, new visual presentations and stronger window execution. We also employed associated training, which included new ways to engage our customers in the fitting room, a place where conversion happens. These practices have been rolled out, and we will continually review and refine them going forward.

On our Web site, we are working to reflect an improved brand image and improve the customer experience. We recently made a few customer-focused enhancements such as bringing her shopping bag across multiple devices, adding a mobile store locator with GPS and increasing speed.

We are working on a re-skin of the site with an updated look and feel that incorporates social elements, a greater focus on fashion content, improved user experience and a more streamlined checkout. The newly re-skinned Web site is scheduled to launch later this year.

Our catalog continues to evolve with a strong franchise and key item focus, new models, better photography and an overall stronger image that connects with our girl. We are testing many facets of our catalog including frequency, formats and page counts in order to determine how to most efficiently drive traffic to our stores online, or also improving conversion.

Fourth, our operating expenses and financial position, we recognize the need to preserve cash. We mentioned that we reduced SG&A and overhead expenses with a thorough line-by-line review of our costs resulting in savings in the fourth quarter as compared to the same period last year. We also began testing more cost effective ways to distribute our catalog that will enable us to deliver consistent brand communication, while redirecting savings and increasing our efforts across all of our digital platforms.

Many of you already know we are in the process of completing a private placement transaction that we believe will provide the financial liquidity needed to execute dELiA*s turnaround. Dave will provide you with more details around the transaction.

While we are still in the early stages of a turnaround, we believe that we have made tangible progress in executing on key initiatives that will set the stage for improved and more consistent financial performance. Our newly assembled team is working to achieve our mission for dELiA*s, and we are encouraged by the response to the new product and our customer's engagement so far. We look forward to sharing our continued progress on the next call.

David Dick will now take you through our fourth quarter results.

David Dick

Thanks, Tracy. All of the results discussed today will be for continuing operations only, unless we state otherwise. Please note that the fourth quarter of fiscal 2013 contained 13 weeks while the fourth quarter of 2012 contained 14 weeks.

Total revenue for the fourth quarter of fiscal 2013 decreased 34.3% to 35.3 million from 53.7 million in the fourth quarter of fiscal 2012. Total revenue for the retail segment for the fourth quarter of fiscal 2013 decreased 33.5% to $21.9 million compared to 32.9 million in the fourth quarter of fiscal 2012, including a comparable store sales decrease of 26.9%, primarily due to lower traffic in average unit retail, as well as a reduction in store count.

For the direct segment, total revenue decreased 35.5% to $13.5 million in the fourth quarter of fiscal 2013 compared to 20.9 million in the prior year period, primarily due the decrease in Web site traffic as well as lower average order values.

Catalog circulation for the fourth quarter of fiscal 2013 decreased 4.3% compared to the prior year quarter. Total gross margin in the fourth quarter of 2013 was 7.6% compared to 29.6% in the prior year quarter. This decrease is primarily due to lower merchandise margins and increased markdown of other inventory reserves in connection with clearing underperforming legacy inventory, as well as the deleveraging of occupancy expenses on lower revenues.

Gross margin for the retail segment, which includes distribution, occupancy and merchandizing costs was negative 4.3% for the fourth quarter of 2013 compared to 21.1% in the prior year period. The decrease includes 1100 basis points reduction in merchandise margins and 500 basis point reduction related to increased markdown in other inventory reserves in connection with clearing underperforming legacy inventory, as well as a 980 basis point reduction due to deleveraging of occupancy cost on lower revenues.

Gross margin for the direct segment in fourth quarter of fiscal 2013 decreased to 26.9% compared to 43.1% in the fourth quarter of the prior year. The decrease includes 1100 basis point reduction in merchandize margin and 260 basis point reduction related to increased markdown in other inventory reserves in connection with clearing underperforming legacy inventory, as well as 140 basis point reduction due to increased shipping and handling cost as a percent of revenues.

SG&A expenses were $20.6 million or 58.4% of revenues in fourth quarter of 2013 compared to 23.2 million or 43.2% of revenues in prior year quarter. The decrease in SG&A expenses in dollars reflects reduced selling, overhead and depreciation expenses, partially offset by increased stock-based compensation. The increase in SG&A expenses as a percent of revenues resulted from the deleveraging of selling, overhead and depreciation expenses on lower revenues.

During the fourth quarter of fiscal 2013, we recognized a gift card breakage benefit of $0.7 million compared to the benefit of $0.8 million in the fourth quarter of 2012. We also recognized $0.2 million non-cash impairment charge related to underperforming stores during the fourth quarter of both fiscal 2013 and 2012.

Total company operating loss in fourth quarter of fiscal 2013 was $17.5 million compared to the loss of 11.1 million in the fourth quarter of the prior year. For the retail segment, operating loss for the fourth quarter of fiscal 2013 was $11.9 million compared to an operating loss of $6.5 million in prior year period.

The direct segment operating loss for fourth quarter of 2013 was $5.5 million compared to an operating loss of 4.7 million in the prior year period, which included a goodwill impairment charge of $4.5 million.

Income tax expense for the fourth quarter of 2013 was $14,000 compared to an income tax benefit of 0.3 million in the prior year period. Net loss from continuing operations for the fourth quarter of 2013 was $17.8 million or $0.26 per share compared to a net loss of 11.1 million or $0.35 per share for the fourth quarter of 2012.

During the fourth quarter of fiscal 2013, we closed one store ending the period with 101 stores. Subsequent to year end, we closed an additional two locations and currently operate 99 stores. We plan to close another three to five stores during fiscal 2014.

Turning now to our balance sheet, at the end of the fourth quarter of fiscal 2013, we have cash and cash equivalents of $3.3 million compared with 16.8 million at the end of the fourth quarter of fiscal 2012.

Availability under our credit facility was $1.3 million as of the end of the fourth quarter of fiscal 2013, net of borrowings of $14.5 million. In addition, we have restricted cash of $9.4 million to support letters of credit under our LC facility.

Subsequent to the end of fiscal 2013, we closed on a $44.1 million private placement transaction. This transaction included the sale of 199,834 shares of preferred stock for an aggregate purchase price of approximately $20.0 million, and the sale of approximately $24.1 million in principal amount of 7.25% secured convertible notes. Each share of preferred stock is convertible into 125 shares of common stock at a conversion price of $0.80. The notes will automatically convert into 241,166 shares of preferred stock upon stockholder approval of an amendment to our certificate of incorporation that would increase our authorized common stock.

We will use the net proceeds for working capital and general corporate purposes, including investments in storage systems and the Web site enhancements as Tracy mentioned earlier. We cannot use the proceeds from the sale of the notes until receiving stockholder approval of the increase in authorized common stock.

Total net inventories were 19.5 million at the end of the fourth quarter of fiscal 2013 compared with 24.8 million at the end of the prior year period. For the retail segment, inventory decreased to $13.2 million at the end of the fourth quarter of fiscal 2013 compared with 15.6 million at the end of the prior year period. Average inventory per store in dollars is down 8.9% compared to the prior year.

In the direct segment, inventory decreased 31.4% to $6.3 million compared with $9.2 million at the end of the fourth quarter of fiscal 2012.

Cash CapEx for fiscal 2013 was $2.8 million compared to 3.9 million for the prior year period. We expect capital expenditures for fiscal 2014 to be between $3.5 million and $4 million.

Since we are in the early stages of our turnaround, we will not be providing guidance for fiscal 2014 at this time. As Tracy mentioned, we do expect to achieve $5 million in cost savings to reductions and overhead, selling, freight and occupancy expenses.

We will prudently invest in the business where necessary while diligently managing our expenses as we proceed through the turnaround.

I'll now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go first to Justin Ruiss with Sidoti & Company.

Justin Ruiss - Sidoti

Good afternoon. I just had a question. I know that in the prepared remarks there was something said about 25% reductions in inventory. I think the only question I really have is, are there major concerns or is there any kind of work around on possible future markdowns that you might have to take? If you could speak to that, that would be great.

David Dick

Yeah. Justin, we talked a lot about it in regards to Q4 where we worked hard to clear large amount of legacy inventory. We ended the year, as Tracy mentioned, about 60% of our inventory at that point in time is new product. There is still some legacy inventory that we are going to work through over the course of the first half of this year, but we feel we are appropriately reserved from a markdown perspective.

Operator

We'll go next to Brian Gaines with Springhouse Capital.

Brian Gaines – Springhouse Capital

Hi, guys. Can you talk at all about February or March comps?

Tracy Gardner

No. We can't talk about -- we are not talking about forward performance. At this time what I can tell you is we are in the beginning stages of the turnaround and in a tough environment. And I have to say, I'm very pleased and encouraged by where we are in the turnaround at this point in terms of the ability of our teams to get our inventories in line. The product is getting sequentially improved. The stores are looking better and better everyday. Our web catalog or social media performances is improving by the day. I am really pleased with where we are at this stage in the turnaround, and frankly, this is where they expect us to be.

Brian Gaines – Springhouse Capital

Okay. So, when you say things are building sequentially, does that mean comps are getting better or we should expect that?

Tracy Gardner

No, I'm not saying that. What I'm saying is I'm pleased with where we are at this stage in the turnaround. I am not giving forward projections on our performance.

Brian Gaines – Springhouse Capital

Okay.

Tracy Gardner

We are not in a stage in our turnaround to do that.

Brian Gaines – Springhouse Capital

Okay. And then, are there any -- what kind of signs as investors should we look for, or expectations should we have or starting to see some tangible element in the financials of the turnaround?

Tracy Gardner

I'd expect to see relative sequential improvement.

Brian Gaines – Springhouse Capital

Okay. In performance, you are saying, in financial performance?

David Dick

Yes.

Tracy Gardner

Yes.

Brian Gaines – Springhouse Capital

Okay, great. Can you talk at all about the teen environment if you've seen anything let up or does it continue to kind of feel the same in terms of the promotional environment of your competitor?

Tracy Gardner

Because we are in such a different stage of turnaround than anyone else, I mean we are up against obviously tough performance. What we are focused on is building better product, creating a better store presentation and environment, re-engaging our customers through social media.

So, our efforts are really focused in a very different way. We see everyday an opportunity to drive traffic to re-engage the customer; we are making sure that our product investments are better timed and thoughtful, we spend a lot of time on our processes as a team. We are much more physically disciplined across direct and retail. We have created incredible reporting. They gives us stronger visibility on the performance of our inventory and gives us forward forecast to help read trends. We are focused a lot on keeping our money fluid, so that we can chase our trends or respond to our customer. So, we are in a very different stage given the stage of our turnaround. And we are not really paying attention to the external environment. We are paying more attention to what we can do and how we can sequentially improve our business against ourselves.

Brian Gaines – Springhouse Capital

Okay. And then, for David, will the recent deal affect the NOL? Assuming, I guess shareholder approval?

David Dick

Yeah. We are currently reviewing that. The analysis will be completed in conjunction with the shareholder approval and it's under review as we speak.

Brian Gaines – Springhouse Capital

Okay, thanks.

Operator

We'll go next to Joe Yurman with 1221 Capital Management.

Joe Yurman - 1221 Capital Management

Hi, Tracy, it's a pleasure to speak with you.

Tracy Gardner

Hi, Joe.

Joe Yurman - 1221 Capital Management

How are you doing? Investors on previous calls have made reference to this idea that when an executive with a great reputation walk into a business with a not so great reputation. It's the reputation of the business that stays in tact. And I just want to take that idea to the next level and attempt to size the opportunity for us here. So, when I look back at the record of dELiA*s, I can see evidence of an undifferentiated business and unable to grow sales and profitability and return. So, at this point, I'm very clear on one thing, I've invested our capital in a highly capable and proven manager and a talented team and not at this time a great business. So really I just have two questions.

Can you help me understand why this business has generated such mediocre results for over a decade? And I guess on the back of that, what was not being done that is now being done presents the opportunity? And then I have a follow up.

Tracy Gardner

Well, I tend to look forward, and I not look back. But here is what I can tell you and here is what I can say. We have a strong sticky brand, I'm in our stores constantly, just in our stores again yesterday, I follow all of our social media platforms, which I encourage anyone who is in the teen business to get to know those platforms and watch what happens on them. And I can tell you that we, our stores are not overbuilt that we have an incredibly powerful brand that is very, very -- that resonates beautifully with the team. And what we have to do, this business is a product brand business, and it's connecting with your customer. And frankly, we do not have the product that she wanted.

What's fascinating for us and what's exciting for us is when we get it right, she responds and she really does come to us for very specific reason. We offer trend and outfit resource. We are her trusted editor. We are her only store that can speak to her alone as a girl and be in the fitting room and work with her and trust us. We have incredible franchise category, she loves our denim fits, she loves our graphic tees. And what we have just seen before, I think is a mal-aligned product and product which does not resonate with her. But dELiA*s is a great brand. And that's why it's still standing. And we are really encouraged by where we are in the turnaround.

Joe Yurman - 1221 Capital Management

Well, that's very helpful. And so, I realize based upon your comments and your opening that this next question is likely premature, but I think we all welcome the opportunity as soon as you think it is something possible to hear what you think dELiA*s can achieve, and how we are going to get there?

This is a business that has generated 200 million of sales for a decade. Is this a $400 million business, $1 billion? We had 50% gross margins in '99. Can we go north of that? And I understand you are not going to talk about that today, but for those of us who are really concerned about the next 90 days really look forward to hearing a three to five year plan.

Tracy Gardner

Yes. And as you are still well put, we are not prepared to discuss that today. It's too early in our turnaround. But someday, we will talk about it.

Joe Yurman - 1221 Capital Management

Okay, fair enough. Thank you.

Tracy Gardner

Thank you so much.

Operator

We'll take our last question from Lee Cooperman with Omega Advisors.

Lee Cooperman - Omega Advisors

Yeah, thank you. I can appreciate the inability to talk about specific momentum sales, but can you say you are pleased with the status and turnaround? You know that you have raised $44 million subsequent to the end of the quarter. Are you comfortable that you had the financial resources now to execute on your program?

Tracy Gardner

Yes, I am.

Lee Cooperman - Omega Advisors

Good. Good to hear. Thank you. That's the only question. Good luck.

Tracy Gardner

Thank you.

Operator

We've no more questions at this time. I'll now turn the conference back over to Ryan Schreiber for any additional or closing remarks.

Ryan Schreiber

Thank you all for participating in our fourth quarter earnings conference call. Have a good evening.

Operator

That does conclude today's conference. We thank you for your participation.

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