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The Wet Seal, Inc. (NASDAQ:WTSL)

Q1 2014 Results Earnings Conference Call

May 27, 2014 4:30 PM ET

Executives

Christine Greany - The Blueshirt Group

John Goodman - Chief Executive Officer

Steve Benrubi - Chief Financial Officer

Analysts

Liz Pierce - Ascendiant Capital Markets

Jeremy Hamblin - Dougherty & Company

Steph Wissink - Piper Jaffray

Eric Beder - Brean Capital

Marni Shapiro - The Retail Tracker

Janet Kloppenburg - JJK Research

Jeff Van Sinderen - B. Riley & Company

Operator

Greetings, and welcome to The Wet Seal Incorporated First Quarter 2014 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Christine Greany. Thank you. You may begin.

Christine Greany

Good afternoon, everyone. Thank you for joining us today. Presenting on today’s call will be John Goodman, Chief Executive Officer; and Steve Benrubi, Chief Financial Officer.

Before we begin, I would like to remind you that today’s call may contain forward-looking statements. Information and factors that could cause our actual results to differ materially from the forward-looking statements, as well as reconciliations of non-GAAP to GAAP financial measures, are included in today’s press release as well as our most recent annual report on Form 10-K. These documents are available on our corporate website, wetsealinc.com. The company assumes no obligation to publicly update or revise our forward-looking statements to reflect subsequent events or circumstances.

And with that, I will now turn the call over to John to begin.

John Goodman

Good afternoon, everyone. Thanks for joining us today. As we anticipated, our first quarter results were impacted by the external factors that have been weighing on retailers for months. Soft mall traffic, elevated promotional levels and disruptive weather all combined to pressure sales and margin, most notably during February and March.

We did see some improvement in business during April particularly Easter week. For perspective, comp store sales moved from negative low 20s in the first two months of the quarter to negative mid single digits in the final month. We are not at all satisfied with these results but we feel confident that the execution of our four-point strategy is beginning to move the business in the right direction.

We are beginning to see positive response to our refined product strategy. We are establishing more of a key item presentation in the stores and given the customer a greater number of options that you can mix and match while incorporating footwear and accessories into those looks. This has been enabling us to broaden the appeal of our higher-margin categories and should allow us to drive additional units per transaction.

In the first quarter, UPT on a comp store basis was up 2.7%. Dresses, skirts, screen tees and footwear were best performing categories while shorts and accessories proved to be the most difficult. This quarter, we’re introducing some dressy or going out product to complement our more casual looks.

First quarter merchandise margin declined approximately 500 basis points, primarily reflecting higher marketing levels and response to soft traffic and disruptive weather. Our core teen customer is coming to the mall as often and the promotional environment remains elevated from historical levels.

We are moving towards a more targeted approach in using all store promotions on a very limited basis to help drive traffic. In the first quarter, we implemented our high-low pricing strategy. When combined with targeted and attention-grabbing promotions, this is starting to provide us with greater promotional power and we anticipate that it will help us preserve margin going forward.

For example, we’ve had good success with our targeted promotions on dresses, a category where we made a conscious effort to make it clear to customer that Wet Seal stands for dresses. On the e-commerce front, we made tremendous progress in the first quarter in terms of functionality, responsiveness and overall capabilities.

We stabilized the site, completed our team reorganization and began to draw on the knowledge of our three newest Board members who have a wealth of experience in social, digital and e-commerce. In the first quarter, Wet Seal e-commerce sales were up 8.4% and represented 6.8% of our Wet Seal division sales.

Our strategies around email, texting and retargeting are beginning to have a positive impact on traffic and conversion. Notably mobile now represents more than half of the Wetseal.com traffic with our highest conversion rates coming from desktop.

Although margins were down for the quarter as we utilized promotions to reengage Wet Seal customer line and build the e-commerce business, we saw sequential improvement as the quarter progressed. And this continues into the second quarter. We are seeing our digital marketing and social engagement strategies begin to drive traffic and conversion, which is enabling us to gradually reduce promotional levels and generate improved margin.

Because we have a structural advantage of in-house fulfillment, we’re able to be a little bit more aggressive on promotions and store margin well. Our key priorities for e-commerce in the second quarter are as follows. First, Wet Seal will become featured merchant on the Oink website and begin offering our payment technology.

As many of you probably know, it was one of the first payment systems developed for kids and teens. We think that this is a great add-on for our customers, many of whom cannot transact online because they don’t have credit or debit cards.

The service essentially acts as a PayPal for minors and student customers who will have the ability to use it for in-store payments as well. Another key strategy slated for the second quarter is the introduction of Fanreel on to our website. This is an exciting solution that will enable us to integrate fan generated photos into our product pages and allow our customers to sharp these looks.

Fanreel is optimized for both noble and desktop and can be customized to mirror the look and feel of our site. This is an innovative concept that is designed to make fans feel more connected to their favorite brands, drive affinity and inspire purchasing.

Lastly, we’ll be establishing Tumblr on Wet Seal and Wet Seal Plus and launching a dedicated effort to create engaging content and create it for that site. Our customers are avid users of Tumblr, which makes us an obvious place for us to deploy resources.

Social media continues to play a critical role in our marketing efforts. And we are utilizing this to help us establish Wet Seal as a relevant brand among our core teen customer. With the strong presence on key sites, including Facebook, Instagram, Twitter, Wanelo, Snapchat and Pinterest that are all generating traffic to wetseal.com.

Our 2014 model search was highly successful with the number of entries more than doubling versus last year. This year’s competition also includes plus sizes which coincides with our expansion plans for Wet Seal Plus and leverages the propensity of this demographic to more frequently engage in social media.

We are continuing to see growth in our email and texting databases from initiatives like the model search as well as our partnerships with the emerging musical artists and draw new interest through contests and special promotions. Additionally, in the first quarter, we began utilizing social analytics tools t provide us with a key metric around social patterns, most engaging content and follower growth. This will help us ensure that we are utilizing the most effective digital strategies and generating strong returns on those investments.

Turning now to the closure of Arden B. It’s never an easy decision to eliminate jobs and we are enormously grateful to all the dedicated Arden B team members for their hard work. We are well under way with our exit strategy, which is primarily two-fold.

Number one, we are closing stores as quickly as possible through lease expirations and early termination provisions. And two, our Arden B locations remain open. We are in the process of transitioning those stores to Wet Seal brand merchandise.

We have cut nearly all the remaining Arden B receipts and expect every current basis, 54 stores fully set with Wet Seal and Wet Seal Plus merchandise in time for the back-to-school selling season. 31 of these locations will feature Wet Seal Plus and the remaining 23 will feature Wet Seal product.

We are planning a number of marketing initiatives around the conversions to ensure that we build awareness and help drive traffic to those newly branded locations. This will include in-mall marketing, special opening events, blogger partnerships and potential celebrity tie-ins.

We are leveraging the need to wind down R&D in order to accelerate the planned expansion of our plus business. The majority of the stores are in highly visible locations that can provide a strong launching pad for the brand.

Over half of the 31 locations are in malls, with other national plus size concepts which can serve as a natural driver of traffic. Our future plans for Wet Seal Plus included additional store openings in a combination off-mall and outlet locations. With tremendous conviction about the dynamics of this market segment and the potential for both intermediate and long-term growth.

Moving now to our second quarter financial guidance and the current tone of business. Sales trends have been challenging in May and we are up against the very difficult comparison to the second quarter of last year, which was our strongest period in fiscal 2013. For perspective, we achieved the 3.7% comp store sales gain and merchandised margins improved 470 basis points in Q2 of last year.

Additionally May was the best month of the quarter with a positive mid single digit comp. Mall traffic continues to be an issue. Although we are seeing pocket of strength from certain weekends, we feel that our product, pricing, promotional strategies are helping us to start to gain traction.

And therefore the forecast for the second quarter assumes materially better performance in June, July including modest sequential improvement in merchandise margin. We entered the second quarter with inventories up approximately 7% which will help support the transition of the Arden B locations to Wet Seal product by the end of the period.

We remain committed to our fastidious inventory management practices and expect to enter the back-to-school selling period with inventories well positioned. We’re also carefully managing cost during these exceptional times looking at every opportunity to reduce expenses.

Most recently, the Board of Directors took action to lower our directive compensation by 20% and decrease the size of our Board from 9 to 7 members. Additionally, the closure of Arden B will move $1.3 million of cost on an annual basis.

I want to thank our shareholders for their support during this difficult time and assure you that our Management and Board are working diligently to reverse our negative trend, preserve cash and ultimately return the business to profitability. I also want to recognize the dedication and hard work of all of our associates throughout the organization.

Now I’ll ask Steve to review the financials.

Steve Benrubi

Thanks, John, and good afternoon everyone. First quarter net sales totaled $116.7 million, down 16.9% versus a year ago. Consolidated comparable store sales including e-commerce decreased 16.9%.

On a comp store basis, combined average unit retail declined 8.6% to $9.02 and transactions per store were down 11.7%. Our units for transaction increased 2.7%. As John noted earlier, the increase in UPT primarily reflects our refined product and merchandising strategies. Combined e-commerce sales in the first quarter were up 1.9% from a year ago.

In the Wet Seal division, first quarter net sales were $103.3 million, down 15.9% versus last year, while comparable store sales declined 16.5%. E-commerce sales increased 8.4% to $7.1 million. On a comp store basis, AUR decreased 8.4% to $8.22. Transactions per store were down 11.3%, and UPT was up 2.4%.

At Arden B, net sales were $13.4 million, down 24% versus last year. Comparable store sales were down 19.4% and e-commerce sales declined 20% to $1.5 million. On a comp store basis, AUR decreased 6.3% to $29.97. Transactions were down 17.2% and UPT was up 3.7%.

Returning to the income statement, first quarter gross profit came in at $23.1 million compared to $42.2 million a year ago. Our gross margin was 19.8% versus 30.1%. The year-over-year decline primarily reflects a decrease of 500 basis points in merchandise margin as well as the deleveraging of occupancy cost by 470 basis points.

Additionally, our buying, distribution, planning and allocation costs deleveraged by 50 basis points combined. As John mentioned, we’re up against tough comparisons in the second quarter. And while we do anticipate sequential improvement in gross margin from Q1, we expect to see continued pressure on a year-over-year basis.

For reference, in the second quarter of last year, gross margin was 29.6%. Our goal is to build upon the merchandising strategies initiated early this year to continue sequential margin improvement into the second half of the year.

Selling, general and administrative expense dollars in the first quarter were essentially flat at $37.5 million. As a percentage of sales, SG&A came in at 32.1% compared to 26.7% a year ago. Selling expense totaled $28.5 million, reflecting a year-over-year decline of 5.3% on a dollar basis, due primarily to lower store wages and benefits. As a percentage of sales, selling expense was up 300 basis points, driven mainly by the overall deleveraging effect of our comparable store sales decline.

First quarter G&A expense totaled $9 million or 7.7% of sales which compares to $7.3 million or 5.2% of sales a year ago. The year-over-year increase is primarily due to the fact that in the first quarter of fiscal 2013, we had $3.5 million benefit to reverse a loss contingency related to legal matters offset by $1.7 million in higher legal fees.

Operating loss for the period was $21.7 million compared to operating income of $3.2 million last year. The results include non-cash asset impairment charges of $7.3 million this year and $1.6 million in the first quarter of last year.

The first quarter of 2014 also includes $300,000 of charges related to Arden B exit cost and a benefit of $500,000 for nonrecurring other income. The charges related to Arden B include approximately $100,000 for severance while the balance is related to other wind down costs such as the write-off of store supplies.

Operating income in the first quarter of fiscal 2013 also includes the benefit to adjust the loss contingency that I just mentioned. After taking these factors into consideration, non-GAAP adjusted operating loss which excludes the charges and benefits I described, was $14.6 million in the first quarter of fiscal 2014 compared to operating income of $1.3 million a year ago.

Interest expense totaled $400,000 and reflects the cash interest and original issue discount and deferred financing cost amortization on our senior convertible notes, which will continue using the effective interest method over the term of the notes. Additionally, the initial $5.7 million value of the warrants and embedded derivatives associated with the convertible notes will be marked to market quarterly, with the charge or benefit recorded as a gain or loss on warrants and derivatives liabilities on the P&L.

Non-GAAP adjusted net loss was $15.1 million or $0.18 per diluted share in the first quarter. This excludes the after-tax effect of the asset impairment charges as well as the Arden B exit costs and benefit from miscellaneous income I just noted, and a benefit for a gain on warrants and embedded derivatives liabilities. In the first quarter of last year, non-GAAP adjusted net income was $1.3 million or $0.01 per diluted share.

Moving now to the balance sheet, inventories at quarter end stood at $38.8 million, up 6.8% versus a year ago. This was essentially in line with our expectations and will support our plan transition from Arden B to Wet Seal merchandise in 54 locations during the second quarter.

We ended the first quarter with $54.5 million of cash and cash equivalents and short-term investments, $21.5 million of convertible debt, net of discount and a $35 million revolving credit facility available to us, of which $5.4 million is being used for normal course letters of credit.

Cash used from operations during the period was $14.5 million. Capital expenditures totaled $2.7 million, which included expenditures to open four new Wet Seal stores and remodel Wet Seal stores.

Looking at our real estate plans for the year, we are on track to open 10 Wet Seal stores including six outlets, two off-mall and two West Seal plus locations. During the first quarter, the four new store openings were comprised of three outlet stores and one off-mall store. The connection with lease expirations, we expect to close approximately 23 Wet Seal stores in fiscal 2014, one of which was closed during the first quarter.

Now, I will turn to our financial guidance for the second quarter of fiscal 2014. Our expectations are as follows. A comparable store sales decline including e-commerce ranging from negative 8% to negative 11%, and a net loss in the range of $0.09 to $0.12 per diluted share before non-cash asset impairment charges and a benefit from the termination of our supplemental employee retirement plan related to a former Wet Seal Chairman. The expected range of $0.09 to $0.12 includes a loss of $0.02 per diluted share from the Arden B business segment.

We appreciate your participation on the call today and now I will ask the operator to begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from line of Liz Pierce with Ascendiant Capital Markets. Please proceed with your question.

Liz Pierce - Ascendiant Capital Markets

Thanks and good afternoon, guys. Steve, I hate to ask you to do this, but I couldn’t quite keep up with your metrics. So just on a housekeeping, would you mind just repeating those specifically for the Wet Seal division?

Steve Benrubi

I’m sorry, the sales statistics.

Liz Pierce - Ascendiant Capital Markets

I’m sorry, the comp metric -- the UPT, AUR?

Steve Benrubi

Sure. Yeah for the quarter, the transactions per store were down 11.3%. AUR down 8.4% and the units per transaction were up 2.4%.

Liz Pierce - Ascendiant Capital Markets

Okay. Thanks. So in terms of the real estate, remind me how many you had originally planned to close for Wet Seal. I guess my question is all of these or just to be clear, all of these stores are stores that are coming up for lease expirations and I’m just trying to figure out if any of those stores were that you threw in, the additional, were losing money on a four-wall basis?

Steve Benrubi

Yeah, they were -- I think, originally, we were in the high teens estimated for closures of Wet Seal for the year. These are all on lease expirations, so we walk away from the store at that point at no additional costs. And the additional stores, it’s really just a combination of whatever the proposed lease terms for renewal were from the landlord or what we could negotiate and what that translated to a cash flow was, on a few more cases not acceptable to us and so a few more closures are going to be happening. Certainly stores that if they were, if they had tough business leading into that point, we would have to be seeing some decent concessions from the landlord to renew, or else there is a good possibility we would close and that always gets factored in.

Liz Pierce - Ascendiant Capital Markets

Okay. Okay. So basically, the base becomes refined and more productive by adding these additional in.

Steve Benrubi

Yes.

Liz Pierce - Ascendiant Capital Markets

Okay. And then, John, you had some really good information here. But could you just give me a little bit more clarity when you talk about the high-low pricing strategy? How that might -- we might see that for the fall season without giving anything away, but just maybe give a little more detail, little more specifics on that?

John Goodman

Sure. Without going into too much details, we as you know, we started really the strategy of working with the merchant team in mid-January to start executing that at the beginning of March and to April, and that continues into May through the balance of the year. So what we’ve looked at is really strategically looking at our pricing, understanding that the promotional environment is still very strong in the mall today. So really being able to compete effectively, looking at certain categories or prices within our categories. And where we think it’s appropriate, we have raised some ticket prices on certain items throughout.

By doing that, we also really went after more of a key item business, so it’s a two-pronged approach. We’ve got high-low strategy, so we are able to offer that customer additional discounts as well as buying more key item focus, so both of those same started really in mid-March, early April. We are starting to see the benefits of that and certainly going into back half of the year, we feel very comfortable with the strategy going forward and we’ve seen some early wins with it.

Liz Pierce - Ascendiant Capital Markets

So it presume for like back-to-school you would take something similar in terms of category like you did with dresses and it could be dresses, and kind of receive a similar kind of promotional cadence where you really emphasize a particular category?

John Goodman

Yeah. It’s both. It’s categories as well as throughout the stores, certain items that we are buying that are strategic in terms of the high-low strategy. So it’s a double-pronged approach but certainly looking at categories and we feel appropriate, as we did for dresses and went after the dress business for the first half of the year.

Liz Pierce - Ascendiant Capital Markets

Okay. I’ll ask my other question and then I will get back in the queue. In terms of the guidance, I’m just trying to understand. But your e-commerce business was up and yet obviously it is still a small percentage. I don’t know if you actually specified what it was as a percent of sales, I might have missed that. But I’m more trying to nail down why the comp decline is still as negative as it is and will Arden B -- is Arden part of that guidance or is that excluding Arden?

Steve Benrubi

Are you speaking of e-commerce or the guidance for the company?

Liz Pierce - Ascendiant Capital Markets

Well, basically both. I’m trying to figure out if e-commerce was up this quarter and you expect these product improvements and your mobile strategies and your social media strategies continue to drive traffic and hopefully conversions. Why the comp decline of negative 8% to negative 11% and then, sorry my mind is just -- and then does all of that include Arden? Is Arden in the guidance?

Steve Benrubi

I will speak to a few things there, Liz. Yes, Arden is part of the guidance for the second quarter. Its e-commerce performance and stores are within the numbers. For the first quarter, just by the way of little bit order of magnitude, the e-commerce we talked about at the Wet Seal division alone was up 8.4% in e-comm and with Arden included, e-comm was up about 1.9%. The e-comm overall improved the overall comp numbers by a little lower 1 percentage point in Q1.

And I guess just lastly, we had called out the e-commerce division percent of sales. It was 6.8% of the Wet Seal division sales in Q1 in e-commerce. So overall, all those things give you some sense of magnitude there. From our standpoint, looking at the comps guide for the quarter as John talked about, up against our most difficult compared of the year, last year where we were up over 3% comp. We are looking at a two year comp build where the decline is about a mid-single-digit in Q2. And that’s fair amount of progress over the Q1, if you look at it on the same basis which was in the high teens. So, we do feel like we are making progress toward our goals in terms of the direction of the comp performance from Q1 to Q2.

Liz Pierce - Ascendiant Capital Markets

Got it. Okay. I will get back in the queue and if I don’t talk to you, I look forward. Thanks.

Steve Benrubi

Thanks, Liz.

Operator

Thank you. Our next question comes from the line of Jeremy Hamblin with Dougherty & Company. Please proceed with your question.

Jeremy Hamblin - Dougherty & Company

Good afternoon and thanks for taking my questions. I wanted to just clarify to Steven and John. In your prepared remarks, I think you had said that May has been pretty difficult thus far and that your guidance for the quarter assumes a material, I believe is the word you used, improvement in June and July. Part of that I assume is just you get a little bit easier comparison because May was the best month last year. But is there another reason in which you are feeling more confident going forward about the next couple of months of performance?

John Goodman

Jeremy, this is John. I think one of the things we see, we talked about May being the toughest compare of the quarter, significant improvement last year in May in terms of comp performance. What we’ve noted in the month of May, when Mother’s Day, we had a very strong performance and for the four days it just happens with Memorial Day where our comps are down 5.4% versus last year as comp being up 14%. So in terms of the improvement, we are starting to see that.

As we get past, we are certainly pleased with our performance in the past four days from Memorial Day. What’s still tricky for us is, when there is not a holiday or holiday week, we don’t necessarily see that traffic as consistent as it was last year. So as I talked about earlier, the girl is not shopping as frequently as she was in the past. So that’s still weights on our thinking go forward, but certainly we did see some real signs of [one each one] (ph), when the girl is in the mall, when she goes there for either a holiday or an event, we are getting early in our stores.

Jeremy Hamblin - Dougherty & Company

Do you have a sense for how your conversion rates are? I know you don’t formally have that number, but do you have a sense that conversion rates are improving or can you give us any color on that?

Steve Benrubi

Transactions usually being our proxy as well as following external numbers discussed that get discussed regarding traffic. We believe that when she is coming in the store, we are getting our share, we are getting her attention and we have the product for here. In that period that John talked about, we saw some encouraging move in transaction trends over this holiday weekend. We know she was out there and transactions responded very well over the holiday weekend to help support the improvement in the comp, so we takeaway some encouraging metrics from that.

Jeremy Hamblin - Dougherty & Company

And then just following up on this, in terms of where the improvement in comps is likely to come from, I think you said transactions were down little over 1% and AUR is down 8% unchanged. Are you expecting more of the improvement to come on the transaction side or more on the AUR side moving forward?

John Goodman

I think it’s a combination of both. No question that we think, we definitely are seeing our AUR because of new pricing strategy come closer to where we were last year, where we were selling pretty much everything at regular price. And we see transactions starting to pick up. Transactions, the balance of that is -- we are more promotional at certain times. So we are seeing the right balance between our AUR and the transaction. So that combination, we feel like will pay dividends as we get into the back half of the year.

Jeremy Hamblin - Dougherty & Company

And then last question, just in terms of operational cash burn in Q1, I think I’ve got inclusive of CapEx down about $17 million. Was that in line with your internal plan as you gave guidance a couple of months ago?

And then as we look forward Steve into Q2, are there balance sheet in terms of thinking about change in operating assets and liabilities? Is that likely to help you? The inventory levels, even though I know you are doing this transition, do seem high at up 7% versus sales down 17%. Considering the size of the number of stores in Arden B business, it seemed high. So how should I be thinking about the balance sheet side of the equation as you look to lower that operational burn rate?

John Goodman

A couple of things I guess. In the first quarter, when we talked about the operating cash flow, there was about -- I think it was a little over $3 million of use for working capital. We do have in the first half of the year some buildup, net buildup of working capital, inventory being the biggest piece just to be prepared for coming off of the low point at the end of January when the post holiday season brings inventories to its lowest level.

Q2, there is the slight net use of working capital as well built into a model. There is also from a CapEx standpoint, the store openings that we discussed as well as, as our other spending plans is mostly in the early part of the year. This year, about 70% of the CapEx for the year will then completed by the end of Q2. So those things all impact the cash use and we estimate about $11 million of cash used in Q2 along with the guides that we gave today.

You would ask on Q1 was that in line with our expectations? It was, it was within the range that we gave as an estimated cash used for the quarter. I think that might cover the balance sheet side. We ended the quarter with over $80 million of liquidity between our cash and bank line availability and certainly in the mode of making sure we preserve the company’s financial strength.

Steve Benrubi

And Jeremy you asked about the inventory levels for Wet Seal being at 7%, and I think one of the key things for us is we are fast fashion. We have the ability to get in and out of goods. We feel comfortable where our inventory is and it is 54 stores that we are converting over to Wet Seal, Wet Seal Plus from Arden B. So we are building in anticipation of that as we transition the business starting in late June and early July into getting inventory into those stores.

Jeremy Hamblin - Dougherty & Company

Will any of the Arden B inventories just be written off?

John Goodman

No, I think we’ve got a process to sell down due to fairly low levels by the end of the second quarter. We will evaluate different means be it through the e-commerce channel or consolidation in a few stores to complete final selling in the most profitable way we can.

Jeremy Hamblin - Dougherty & Company

Thanks so much for taking my questions.

John Goodman

Thanks, Jeremy.

Operator

Thank you. Our next question comes from the line of Steph Wissink with Piper Jaffray. Please proceed with your questions.

Steph Wissink - Piper Jaffray

Thank you. Good afternoon, everyone. A few questions for you guys. Maybe, John, I will start with a couple for you. Just on the payment system that you mentioned kind of this PayPal for minors, could you just talk about some of the hardware deployment costs or anything that you need to deploy from a mechanism strategy in the stores and actually in order to be able to affect that payment system?

And then secondly, I think you had a really interesting statement regarding kind of your mobile traffic to your website relative to your transactions, the mobile being more than 50% of the traffic, but transactions really being conducted via desktop. If you can just give us some insight into how you actually capture and retain that mobile traffic and move those individuals to a point of transaction on desktop, how do you functionally kind of retain that customer across different platforms?

John Goodman

Well, firstly, the mobile payment system that we are putting in, it’s not very costly at all. One of the things we weren’t able to do is, in first quarter it was very difficult, the transition of demand we’re in and just getting that all right. So our ability to do mobile payment was really around getting demand, we’re up and running. So we’re able to do that and now we’ve been working through to really partner with them. We’ve been working on this for quite some time. We’re very excited about because we do believe like girls using that as well as, as she is also getting a debit card from her parents and she is using to convert with us. So first few things not very costly at all and we are looking forward to working with them on that.

In terms of the mobile transactions, we did see mobile become much more important as again the demand where site was put in and we’ve got all the king shots and certainly at each and by March, we’re feeling very confident about our ability to transact with her on the mobile device. So that we’ve seen that arguably take shape as well as getting her ability to get more text numbers. We’re almost getting back to the levels we’re at last year from a texting capability, the phone number capability. So a lot of those things really play into the omni-channel. We’re actually shopping, whether it’s on desktop or mobile. And we feel like this is just the beginning stages and certainly having the three new board members really are helping to alleviate that thinking and how to convert that customer and now growing some of the ideas that they’re bringing to the table.

We had a great offsite with them in San Francisco a couple of weeks ago where we spent some good quality time with the three new board members about how do we really take this business, the mobile piece of the business and social and digital part of it and really maximize it. So a lot of things are just starting to happen, but the good news is the demand where site is working and it’s working well and now we can start doing additional things about it.

Steph Wissink - Piper Jaffray

Okay, that’s helpful. And then maybe, John, just another question, this is more of a broader question. You mentioned that you really need to maximize kind of those events and you are referencing Memorial weekend as well as the natural flow of traffic is in the mall. So if you just step back and think about a year, if you think about those key event weekends, what does the comp rate need to be? What do you need to win in terms of that battle when traffic arrives in order to really leverage the overall business model? And are the valleys in between those event weekends so deep that it provides some limitation in your flexibility around how dynamic your model is? Just a bigger picture question I guess around how do you maximize the weekends and minimize the risk in between?

John Goodman

I think one of the difficulties during the first part as you know, I hate using weather, but in terms of the weekdays, it really wasn’t a catalyst for people coming out to the mall certainly and continued into early May. So I think there was some of the issues, but when it was a catalyst, whether it’s a holiday or Easter, the two weeks of Easter we felt very strongly as we called it out a couple of weeks ago, and certainly Mother’s Day as I just articulated and Memorial Day. We are now going into summer. And by definition our girls is out and about, so we do believe the traffic will pick up through the summer.

I think as you remember our -- really starting in September our business started to drop off pretty significantly. So we feel like we’ve got the right balance for her when she is in the mall, balancing price and promotion, understanding when she is going in for mall, how do we gather and when she is not how do we maximize the profit during this periods of time. So we learned a lot in the fourth quarter and certainly latter part of third quarter and fourth quarter that we feel like we’ve got the right cadence to weather the traffic at the highs and lows of the peaks and valley so to speak to really start delivering in the back half of the year.

Steph Wissink - Piper Jaffray

Okay, thanks, John. Just a couple for you, Steve, more housekeeping. But I’m wondering if you could give us the comp transactions for e-comm, following up on Liz’s question? If you were to separate out the stores and e-comm, is there something that you would be willing to provide for those transactions, AUR, and UPT just by comparison, because your e-comm business does look like it’s up nicely.

And then also follow-up to the prior question regarding the inventory levels. So if I just look at those 54 stores and the dollar amount of the inventory increase year-over-year, can you give us some sense if you were to strip out the inventory allocated for those store conversions, what the per square foot inventory is in the legacy core business?

John Goodman

Okay. I will start on the e-commerce side focusing on the Wet Seal. The transactions were actually up slightly more than the 8.4% increase in the sales in the quarter and very much in line with it. So it’s really a transaction driven increase to the Wet Seal business that we saw in Q1. And from an inventory standpoint, I will tell you, you could really look at -- I don’t have a specific number, but I think it’s suffice to say most of the increase in the inventory you could look out and say that’s going to help support the fact that we have this transition happening in the second quarter, but we are building starting in early June and July into these 54 stores.

So if you take out of the -- take that into account if you will, you end up with an inventory increase, that’s pretty nominal year-over-year. And it also comes at a time where we are pretty early in the spring summer selling season so that the merchandise and store starting May has a lot of legs to it left if you will in terms of being summer and spring selling and we are comfortable with the position.

Steph Wissink - Piper Jaffray

So where should we expect inventory could be then kind of exiting July once that conversion cycle has occurred?

John Goodman

We would want to see inventories running somewhat in line with comp stores performance and near-term expectations go forward on comps. We feel like historically we’re on the fairly good balance of inventory to sales. So that’s what we want to see.

Steve Benrubi

And the other critical thing is we still have a lot of open to buy in the latter part of this quarter which is important to note that because we are fast fashion, we have that ability to get in another product and we continue to do more domestically. It gives us that ability to chase products certainly in the month of July and forward. So we have that as well. So we are not concerned where we feel like where we can get back into what we need to do in terms of the inventory levels to go into third quarter.

Steph Wissink - Piper Jaffray

All right, guys. Thanks a lot. Best of luck.

John Goodman

Thanks, Steph.

Operator

Thank you. Our next question comes from the line of Eric Beder with Brean Capital. Please proceed with your questions.

Eric Beder - Brean Capital

Good afternoon, it’s a long day. Could you talk a little about the impact of the Wet Seal Plus stores in terms of buying power? And do you look upon this as a test or you look upon this as a next step in evolution here and where can that eventually go?

John Goodman

So if you look at, how we look at the Plus business, we think this is a golden opportunity. It is a test in so many ways. We articulated we wanted to be off-mall, and certainly some of the strategies. And we just had our second Plus store opened last Friday, freestanding Plus store in Packwood in the Central Valley as well in California, and we are very happy with the results for the first few days.

We do see that there is an opportunity to really get some more buying power in terms of how much inventory we’re buying, because the difference of buying for one full store and an e-commerce side or two stores and the e-commerce side is very different than buying for 50 or excuse me 31 stores that we will be buying for us. So in that respect, we do get additional buying power, but we also get the ability to work with our landlords, to work into these A malls and to understand the power of the plus size business and what we are bringing to the table.

So the performance of our two -- first freestanding stores as well as the new one give us some really excitement around the opportunity, but it is still an opportunity and we are still going to be testing the concept all the way through and looking at our leases and working with our landlords. So all in all, it should be seen as a positive and an opportunity.

Eric Beder - Brean Capital

Great. And what’s the conversion cost going to be to take an Arden B and convert it to a Wet Seal Plus or a Wet Seal?

John Goodman

It is -- really there is the signage on the front of the store which is fairly an expensive $2000. We are maintaining the fixturing. We are finding we are going to be able to utilize the vast majority if not all of that within the Arden stores. And turning over to the inventory is one -- it’s going to be Plus inventory carried instead of Arden, no net increase there. So it’s really not a significant spend in order to convert the stores.

John Goodman

And we’re also able to cut basically 67% of our go forward inventory. We did that a couple of weeks ago. So that since that we have no one order as of this week into Arden B anymore. So we have nothing coming in and we’re able to cut two-thirds of the inventory that was on order.

Eric Beder - Brean Capital

Great. Good luck for the rest of the year, guys.

John Goodman

Thanks.

Operator

Thank you. Our next question comes from the line of Marni Shapiro with The Retail Tracker. Please proceed with your question.

Marni Shapiro - The Retail Tracker

Hey guys.

John Goodman

Hey, Marni.

Marni Shapiro - The Retail Tracker

So the stores have looked definitely more focused over the last couple of weeks as I walked in, with clear statements at the front. I think it started around the time you hit that dress presentation sometime in the middle of the quarter. So as I start to think about the second quarter, but really the back half of the year, how should I think about that focus, like what should Wet Seal really be standing for?

I know you’ve kind of toned down a little bit on the denim, the five for $20 looks fantastic, dresses have looked fantastic. So if I am a girl walking past your store, come back to school, without giving away trade secrets, what should Wet Seal stand for, what should the focus be?

John Goodman

I think we can continue on the path of key items and really working on that strategy, the promo strategy that’s been working for us and certainly it’s starting to gain really significant traction. I think there will be categories we’re going to be going after that obviously some I can tell you about, some I can’t just from a competitive nature. But what being we did talk about which is very important and we did leave money on the table in fourth quarter was that dressier element.

And I feel like we’ve got that solved. The stores that you’re going today, you’ll see a whole dress wall is set up hopefully by tonight in all stores. So I will look at that as an opportunity of how Wet Seal does dressing for our girl. And I think it’s very appropriate and we feel really, really based upon the testing we’ve been doing very confident in that. So finding the right balance of casual and dressy, finding the right balance of key item versus fashion, finding the right balance of the denim which we talked about for the back half of the year where we’re still going to be in the denim business, but to have those big monuments of denim malls, you’re not going to see that like you used to. And certainly other categories that we are getting traction and we will continue based upon some of the success we’ve had in the dress category. There are certain other categories we feel like we can go after for fall.

Marni Shapiro - The Retail Tracker

Fantastic. And then when I think about your brand and its placement in the market, at times Wet Seal has been younger or older kind of different places. And now when I walk past, I kind of feel like it’s almost her entry into the fast fashion world, so it feels a little bit younger than, say, a Forever 21 or some of those brands. Is that the right positioning for the brand and where you would like to be?

John Goodman

Yes, absolutely, and I think that’s where we’re going to win. And I think as I said before and when we’re winning last year really understanding that 4,000 square foot box that we play in, understanding the opportunities we have and where we can win and where we can’t win based upon some of our competition, going after that is crucial. And I think we’ve solved for a lot of it.

We’ve had some really good learnings in the past, obviously from the beginning when it started, but certainly as we looked into the fall and holiday and into the spring season, some key learnings for where we can be competitive and where we can compete. The one thing I will tell you which goes back to Eric’s question before is we do believe that Wet Seal Plus is an opportunity for us, because there is really nobody -- there are some players that are doing well on it, but we really think there is room for us to grow and to compete in this marketplace.

And certainly we’re going to be putting our best foot forward. So you think about us in terms of what I just articulated about the key item business, about the fashion, the dressy, you think about e-commerce and you think about Wet Seal Plus, and it really is the four tenants of our strategic plan that are really starting to take shape as against the back half of the year.

Marni Shapiro - The Retail Tracker

Fantastic. Well, I guess that part of the strategy obviously came through because it feels like it is the lead into that older fast fashion, but it’s a little more approachable to that customer first starting to enter. Well, best of luck with summer, guys.

John Goodman

Thanks, Marni.

Operator

Thank you. Our next question comes from the line of Janet Kloppenburg with JJK Research. Please proceed with your question.

Janet Kloppenburg - JJK Research

Good afternoon and hi everybody.

John Goodman

Hey, Janet.

Janet Kloppenburg - JJK Research

Hi. I was wondering, you talked a lot about mix a minute ago, John, and I was wondering if there is an opportunity for perhaps AURs to start to increase again. I know denim is being played down, but I think that bottoms category has in the past helped the AUR levels. And if that’s not the strategy, then are you thinking that transactions are what will drive an improvement in comps?

And secondly, I was just wondering if you could talk a little bit about the large-sized model in terms of store expansions. Do you need as many stores to build out this concept as she shops more online? Is it more of a destination value center concept as opposed to mall-based? I would just like to learn a little bit more about what you were thinking about in terms of building out that business model. Thanks so much.

John Goodman

So, I talked about earlier a little bit about the AUR and where we think as we start to progress and where there was a wide divide from an AUR perspective in the first quarter into early second quarter. I think as you’re seeing the strategy starting to take shape, so the AUR, the divide is lessening each week. We feel really good about that because what that means is it gives us the opportunity to really start to move the business and to be promotional where we need to be but also pay dividend so.

Janet Kloppenburg - JJK Research

Well, does that mean that you’re able to be less promotional, John, as you think, you’ll be less promotional going forward?

John Goodman

No, actually, I think it’s the right balance of promotions because as we look now, we are starting to see the IMU improvement. We’re just looking today again. We are starting to see the IMU improvement. We are starting to see the AUR come closer and certainly this was a very tough month last year for us, so sell-throughs were unbelievable, the margins were great, comps were very strong.

So for us being competitive with this tough month from a year ago gives us really good hope, as we look at softer comparison into the balance for the year. This is the game of both AUR and transactions. So we’ve got to maximize the transactions from those key weekends when the traffic is there. We’ve got to maximize, we got to make sure we have the right promotional cadence and we offset the balance out during the days where she’s not shopping in the mall and really finding the right spread. So, I feel like we’ve got an answer where last year, what happened in September in the fourth quarter, it did take us a little off guard just because no one anticipated that promotional levels that we were at. We’re now able to compete effectively with AUR and transactions.

So, the second part of your question is around plus concept and really for us, having two freestanding stores now, having an online business continue to do extremely well from a plus standpoint and our 35 shopping shops that we really looked it at last year. We move 15 stores out. We move another 10 stores to 20 stores in. So really finding the right balance of the shopping shops, but then now having the ability with 31 stores to really look at these malls, look at where our competition is and being able to maximize this.

We want to see how this does, I think we’ll get some really good reads on working with our landlords, balancing out the real estate portfolio on how we exit some of these stores as Steve talked about earlier but how we continue with other ones. So we’re going to get some really, really good reads starting in, really in mid July. But we launch this in early August. But we’ll start to get some of those reads and we’re very excited about the opportunity for junior plus.

Janet Kloppenburg - JJK Research

I am too. I think it could be a great concept for you guys. Lots of luck, and we will talk soon. Thank you.

John Goodman

Thanks, Janet.

Operator

Thank you. Our last question comes from the line of Jeff Van Sinderen with B. Riley & Company. Please proceed with your question.

Jeff Van Sinderen - B. Riley & Company

Hi, everyone. John, maybe you can just give us a sense on the BOGO 70% off promotion you started running, how we should think about that? What kind of boost you saw in traffic and conversion from that? Just wondering how maybe that impacted your Wet Seal comps and how you think about winning the customer off those kind of promos? I know the environment is still promotional, but any other color there?

John Goodman

Yes, as we talked about, literally, we haven’t run a storewide promotion all year. We planned this a while ago to plan from Memorial Day. Really looking at the business and understanding when the key traffic times are there, we’ve got to participate. And if you saw the mall as you obviously you did, calling out of the BOGO 70. We had to competitive but we did in the way that was profitable for us. So I think part of the ability for our comps to improve as we articulated earlier on the call was around the BOGO 70 being strategic about when we run it.

We can run 40 off the whole store, we can run 50 off the whole store. We ran the BOGO 70 event and really balancing the right promotional cadence, I feel like was the right thing to do and really saving up some of those dollars for important times for us versus trying to run them periodically whether it be in Easter or whether in Mother’s day. We didn’t have to run those events but we really said certain key holiday weekends, we’re going to be participating. And we’re going to be strong out there with the rest of our competition.

Jeff Van Sinderen - B. Riley & Company

Okay. And then based on the improvement that you expect over the next couple of months, this improving trend, just wondering how we should think about merchandise margins for Q2 order of magnitude in terms of sequential improvement there did you expect?

Steve Benrubi

Yeah. We do expect sequential from Q1 to Q2 and also to narrow the gap to the prior year. There is still work to do in terms of getting all the way back there and part of what was challenging in Q2 last year in including the comp performance where there was also a very strong merchandise margin quarter. But the differential, we were down 500 basis points in Q1, year-over-year we look to narrow that meaningfully in Q2.

Jeff Van Sinderen - B. Riley & Company

Okay, great. And then I know it’s really early in the plus size business, but just wondering if there’s anything you could share on the metrics on the two plus size stores you already have open. And then maybe what sort of contribution metrics we should be expecting from the 30 or so that you will have open soon. Also do you need to hire any new talent for plus size? Maybe you can just talk more about what gives you confidence in that business as well?

John Goodman

Well, I’ll take the talent question. We feel very strong with the talent we have. We’ve got experienced people that have been in this business for quite a period of time that we’ve hired over the past year. So really from a talent standpoint, we’ve got the merchant team, we’ve got the operating team that understand this business so we feel really comfortable there in terms of talent. And Steve can take the…

Steve Benrubi

Yeah. On the individual stores, I mean, bear in mind we’re talking. One that’s been open since the fall and another one had opened less than a week ago. The store in the fall, off mall location definitely a maturation process that happens with any store in that venue versus in the mall. And we see from month-to-month, sales volume increase, margin quality improve, cash flow performance becoming positive in the business as there is more recognition that were there with the store.

I think we’re about in our seventh month of operation, maybe eight month of operation in that store. As John alluded to you earlier that the stores had opened, I think in the Visalia area, the Central Valley. Very nice Memorial Day weekend opening, I have to say that. We’re pleased with the sales performance right out of the gate and then obviously monitor it closely.

I think these stores that we’re going to have in the mall are going to be as John has said a great test for us and opportunity to evaluate the strength of plus in that setting when you do it solely for that junior customer. And we’ve obviously got some great real estate that we’re going to be in front of a lot of foot traffic from day one on those stores. So we will learn a lot quickly.

Jeff Van Sinderen - B. Riley & Company

Okay. Thanks for taking my questions and good luck for the rest of the quarter.

John Goodman

Thanks Jeff.

Operator

Thank you. I have no further questions in queue at this time. I would like to turn the floor back over to management for closing comments.

John Goodman

I’d just like to say thank you for your participation in the call today and we will talk to you again soon. Have a good day.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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Source: The Wet Seal, Inc. (WTSL) CEO John Goodman on Q1 2014 Results - Earnings Call Transcript
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