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dELiA*s, Inc. (NASDAQ:DLIA)

Q1 2014 Results Earnings Conference Call

May 29, 2014, 9:30 AM ET

Executives

Ryan Schreiber - SVP, General Counsel & Secretary

Tracy Gardner - CEO

Lex Gemas - COO

Analysts

Joe Yurman - 1221 Capital Management

Sean McGuirk - AMICA Mutual

Operator

Good morning, ladies and gentlemen, and welcome to the dELiA*s, Inc. First Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. Later, we will open the phone lines 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 May 29, 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 starting today at 12.30 PM and run through 11:59 PM on June 29, 2014. You can dial-in on 877-870-5176, domestic, or 858-384-5517, international, using passcode 8593263.

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

Ryan Schreiber

Thank you, Tina. Good morning, ladies and gentlemen. If you need a copy of our first quarter press release it is available on our website, www.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 websites.

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 May 29, 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 us this morning. Joining me today is Lex Gemas, our Chief Operating Officer. As we’ve discussed in previous calls, we are in the process of rebuilding dELiA*s. This new team has radically changed the way this company operates, from product development, inventory forecasting and management to a holistic omni-channel view of our customer.

We are building the foundation that will support more profitable and sustainable growth in the future. We are encouraged by our first quarter progress in what continues to be a challenging macro retail environment.

We achieved all our internal financial targets in the first quarter. We saw sequential improvement in both our sales month-over-month and our margin to last year and fourth quarter. Our product margin rates were the highest level we have seen in the last six quarters.

We’ve gained control of our on-hand inventory levels, which are down 17% over last year. These are important first steps that we would expect to see at this stage of our turnaround. In addition, we reduced our SG&A by over 5%, which puts us on track for $5 million in annual cost savings.

As discussed previously, there are four pillars to our plan to transform dELiA*s into a customer-centric, girls-only teen brand that enables her to express her individual style; offer a market developed product assortment that is on trend and value right and that is unique to dELiA*s; provide an omni-channel engaging customer experience; grow our social connection with our customers and drive new customer acquisition; improve processes, technology and customer experience to support our long-term objective of profitable growth.

Our product team has made tremendous progress in developing a lifestyle assortment that addresses our girl’s desire to express herself to her own personal style. We want her to be her best friend in fashion. We want her to express her individual style as it evolves. We saw strong response to several of our fashion categories, including skirts, sweaters, party dresses and woven tops. We also saw our core spring offering of knit tanks and shorts outperform the balance of the assortment.

Our customer is responding to a renewed focus on outfitting, both on the sales floor, in the fitting room, online and in our social channels. Our core denim performance is improving as we introduce new fits and washes. She is loving her high-rise and jegging fits that will gain in importance and dominance in back-to-school.

Our fashion denim comparison is difficult as we anniversary the color denim trend from last year. This comparison moderates go forward. We are testing new bodies and themes in our graphic business. We are creating a faster-response model to continually offer newness to our franchise graphic business.

We are encouraged by the early read as we head the into the all-important back-to-school selling period. We continue to collaborate with the best and strongest teen brands. Our customer loves Keds, Converse and will soon be able to get her beloved Alex and Huntley omni bracelets in our stores for back-to-school.

In addition, dELiA*s will be launching our full products offer in Amazon this fall. We see this as a critical step in expanding our customer reach and engagement. We look forward to giving you more progress on these exciting initiatives in the future.

On the last call, we talked about looking at our business holistically across our store and direct business from an inventory management perspective. We’ve begun to put the disciplines in place to improve inventory management and store allocation processes. We’ve started an enterprise-wide upgrade that will give us the tools to support this effort.

This partially new and partially upgraded software will help us to enhance our sales and conversion capabilities through enterprise selling and customer loyalty program functionality. We expect these technology investments to enable us to improve our traffic and conversion, as well as greatly enhance our overall customer experience. We plan to roll out these systems during the third quarter.

Let’s talk about our omni-channel experience and our growing social connection to our customers. We continue to make huge progress in bringing a unified and relevant brand image across our stores, website, catalog and social media. We remain focused on creating a highly engaged relationship with our customer.

We have many exciting initiatives on the horizon across social media, web, and our stores that we believe will create excitement and help increase brand awareness. As I’ve said before, her primary resource for discovering inspiration is social media, and we are finding creative ways to use this channel to engage with her.

For one, our partnership with influential bloggers have proven to be highly successful. As these influencers share their passion for our merchandise, they enhance our brand image and keep dELiA*s top of mind. We believe these relationships have been effective in driving awareness and we will continue to build new partnerships going forward as a way to connect with our current customers as well as attract new customers to dELiA*s.

We will continue to right size our catalog investments and shift dollars towards digital marketing. We are in the process of implementing an SEO strategy that optimizes our site to increase organic search across all our major search engines which will increase our traffic. These digital campaigns will be in place for the all-important back-to-school season. We are committed to communicating consistent, clear and product focused statements across our windows, website, catalog and other digital assets.

For spring, we highlighted dresses, shorts and tanks, which were among our strongest performing categories for the first quarter. We will continue to focus our product messages across all our touch points.

We believe that providing a strong selling culture in our stores is a key component in the success of our business. During the first quarter, we created styling events in our stores located in our larger markets, and we were very pleased with the strong response by our customers and our store associates. We will continue to expand upon these events for back-to-school season and are expanding upon our Teen Vogue partnership.

Our goal is to provide a dynamic environment that is easy to navigate, visually exciting and fun to shop. We will not wait for the traffic to come to us. We remain on track to launch the [rescan] (ph) of our website and mobile site later this year. The site will feature an updated look and feel that incorporates social elements, a greater focus on fashion content, enhanced photography and improved user experience and a more streamlined checkout process.

Lastly, I will update you on our progress toward reducing operating expenses and strengthening our financial position. We talked about our effort to reduce operating expense, and as I mentioned earlier, we lowered costs by 5% in the first quarter and are on track to reduce costs by $5 million annually starting with 2014.

We continue to do a line-by-line review of our expenses, reduce costs where it makes sense, while reevaluating ROI on all our investments. We remain cognizant of the fact that we need to be prudent with our cash and this is factored into all our decisions.

We strongly believe that we are on the right track to stabilize and turn the business around, ultimately driving long-term value for our shareholders. We are encouraged by the progress we are seeing at this stage of the turnaround and optimistic that we have set the stage to continue to see the sequential improvement. We are dedicated to executing our key initiatives and bringing dELiA*s to a leading position with our teen girl.

I want to thank our entire headquarters, DC, store teams and our investors for their hard work, passion and dedication to helping dELiA*s reach its potential. We look forward to sharing our continued progress on the next call.

Now, I will turn the call over to Lex to discuss our first-quarter financial results in more detail.

Lex Gemas

Thanks, Tracy. Good morning, everyone. Total revenues for the first quarter of fiscal 2014 decreased 26.3% to $25.9 million from $35.2 million in the first quarter of fiscal 2013. Comparable sales, which include comparable store sales and direct-to-consumer sales, decreased 24.7%, primarily due to reduced website and mall traffic.

In addition, catalog circulation for the first quarter of fiscal 2014 decreased 15.2% compared to the prior-year quarter, predominantly due to the reduction in unprofitable circulation. Gross profit, which includes distribution, occupancy and merchandising costs, was 21.3% of revenue for the first quarter of fiscal 2014, compared to 23.8% in the prior-year period.

Gross profit benefited from 260 basis point improvement in reduced obsolescence and other inventory reserves. Merchandise margin rate was down 100 basis points versus the prior-year period, however, the rate improved 1,440 basis points over fourth quarter of fiscal 2013. Gross profit included a 450 basis point reduction due to the deleveraging of occupancy costs on lower revenues.

SG&A expenses were $16.5 million, or 63.6% of revenues, in the first quarter of 2014 compared to $17.5 million, or 49.7% of revenue, in the prior-year quarter. The decrease in SG&A expense in dollars reflects reduced selling, overhead and depreciation expenses, partially offset by increased stock-based compensation. The increase in SG&A expense, as a percent of revenues, resulted from the deleveraging of selling, overhead and cost-based compensation expense on lower revenues.

Total company operating loss for the first quarter of fiscal 2014 was $10.7 million compared to a loss of $9 million for the first quarter of the prior year. Income tax expense for the first quarter of fiscal 2014 was $24,000 compared to $28,000 for the year period.

Net loss from continuing operations for the first quarter of 2014 was $11.3 million, or $0.17 per share, compared to a net loss of $9.2 million, or $0.29 per share, for the first quarter of 2013. During the first quarter of fiscal 2014, we closed two stores and relocated one store ending the period with 99 stores. We expect to close five additional locations during the second quarter of 2014 and another one to two locations over the balance of the year.

Now, turning to the balance sheet, at the end of the first quarter of fiscal 2014, we had cash and cash equivalents of $2.5 million, compared with $3.6 million at the end of the first quarter of fiscal 2013. Availability under our credit facility was $5.5 million as of the end of the first quarter of fiscal 2014, net of borrowings of $11.2 million.

In addition, we have restricted cash of $9.3 million to support letters of credit under our LC facility. As a reminder, during the first quarter, we closed on a $44.1 million private placement transaction. Approximately $20 million of proceeds were immediately available to us, with the remaining $24.1 million becoming available subsequent to stockholder approval at our annual stockholder meeting in June.

This transaction included the sale of [199,834] (ph) shares of preferred stock for an aggregate purchase price of approximately $20 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] (ph) shares of preferred stock up on 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 purposes, including the system investments that Tracy mentioned.

Total net inventories were $24.1 million at the end of the first quarter for fiscal 2014, compared to $26.1 million at the end of the prior-year period. Cash CapEx for the first quarter of fiscal 2014 was $1.1 million, compared to $0.4 million for the prior-year period.

As we’re continuing to work through our turnaround, we will not be providing guidance for the remainder of fiscal 2014 at this time. However, as Tracy mentioned, we do expect to see sequential sales improvements as we build upon the foundations we’ve put in place. We also expect cash CapEx $3.5 million to $4 million for fiscal 2014, expect working capital to be cash positive for the year, and believe we have sufficient resources to execute on our strategic initiatives.

Before I open the call for questions, I’d like to take a moment to acknowledge our press release this morning regarding the resignation of our CFO, David Dick. David has agreed to stay on through August 1 in order to support us during the transition, as a search for his replacement is conducted. And I would like to thank David for his contributions and dedications to dELiA*s over the last six years and I wish him all the best in his future endeavors.

I will now open the call up for questions.

Question-And-Answer Session

Operator

(Operator Instructions) And our first question is from Joe Yurman, 1221 Capital Management. Please go ahead.

Joe Yurman - 1221 Capital Management

Hey, Tracy, I’d like to ask you to share your thoughts on the economics of the specialty apparel industry. I think one of the real eye openers for anyone new to this space. The well-positioned vertically integrated retailers have had a pretty consistent multi-year record of mid-teens operating margins and returns on capital, although this record has been a little less consistent over the past few years. So my question really is has anything changed, has a migration to omni-channel faster flow merchandise selling permanently altered the ability to earn these types of margins and returns? And I guess just to put a cap on it, do you believe that we are positioned to earn these types of margins and returns should the strategy take hold and we’re able to grow the company?

Tracy Gardner

Here is what I would say quickly. Yes, I can answer it emphatically, yes that we are in a position to have this be an incredibly great brand and profitable business having -- it’s funny you know. I think we tend to think things change so much. I think what hasn’t changed is this is a great business to be in. It’s a profitable business. Teens wear a lot of clothes, I live with one. I’m around all her friends. They are obsessed. So what we have to do is create a very sticky brand that appeals to her.

And the good news is right now we are starting to see the signs that we are in fact doing that. And I think that what has changed is the return on invested capital, how many stores does one need and how big will my direct business be. That’s all we’re talking about. The world still wants clothes, the teen is still obsessed with fashion, it is a sport for her. It is an obsession, it is a dream.

And what I love about this business and while I’m so encouraged sitting here today is, I believe we are creating a great teen brand that she is falling in love with. As I’ve mentioned so many times in the past, I’m in our stores constantly. I talk to our field team constantly and I’m always reading customer comments and letters.

And when I first started, it was horrific, it was really terrible. And we still have things to work on, we have lots to work on. But what we are now seeing and particularly in our toughest markets, when I look at New Jersey, when I look at the New York region, we’re starting to see outperformance in those tougher markets. I see those markets as fashionistas. They know what’s what. They know what’s hot. They are the first to discover.

And we’re starting to see some really exciting results in some of our stores. If you go to Menlo Park, I would love for you to go to Menlo Park and see our store. I wish I can live there. It’s amazing, the team is spectacular, the results are amazing. But no, the business hasn’t changed, how many stores you need and how big is your web business has. And what also has changed is how she digests and takes in information and consumes fashion.

She is in the top of the funnel, I’m using a technical term, forgive me, the top of the funnel where she begins to access your brand has changed. It starts on her mobile device, it starts on Instagram, it starts on some blogger that we may not even know who the heck she is and just by some virtue and lucky moment, she has discovered us and started talking about us in Instagram. That’s what’s changed.

So what we are excited about is we aren’t overbuilt. Thank God, we are not overbuilt. So we can make sure that we right size our capital investments to the proper channel, the proper selling channel and what we’ve been spending our time doing, and really I’m blown away I have to say, I know the comps aren’t there yet, but the way we grade ourselves this minute and believe me there is going to be a time where we will grade ourselves on the comps, trust me.

But the current KPI that we should be looking at right now is did we start our customer file growing again because it’s declining by leaps and bounds through the third and fourth quarter. I can now answer yes. Starting in April, we saw a nice shift happen, which is what we look for. Have we gained control, have we created processes to be able to forecast and control our business, because we all know capital is inventory and I can now answer an emphatic yes, I mean that’s why I’m excited sitting here in front of you today, be able to say we hit our financial plans for the first quarter.

That’s a big feat at this stage in the turnaround. And what it does is it sets the stage for our future. We are seeing renewed traffic, it’s still not recovered to where I’d like it to be, but we’re starting to see a shift. These are all incredible signs that tell us we are on the right path.

The team is getting really good at developing products that our customer loves. The team is new and we’re working together, we learned a lot through the first quarter. And what that does is it just makes us smarter and better for the third quarter. We are now coming up against, very soon, that strange plate shift we all felt in the industry last year in the second quarter.

We are coming up upon that and we’re also -- thank God, we’re passing over the comparison to color denim which is glad to see that go. But so a long-winded answer to a great question, this is a great business to be in. I love this business, it is a profitable business and where you get killed is when you have too many stores and not enough customers. And we don’t have too many stores and we’re growing our customers.

Operator

And our next question from Sean McGuirk, AMICA Mutual.

Sean McGuirk - AMICA Mutual

I guess I just had a couple of questions. The first one being, how should we think about, I guess, per square foot inventories as we kind of move throughout the year? Do you -- you guys probably have the plan set at this point, I wondered if you can give me any color on that?

Tracy Gardner

We don’t share to that specific. But what I can tell you is we are putting our inventories to our sales and what we would like to see go forward is our inventories become more productive. And you’ve studied our business over the last several years, I would like to say that we’ve had too much inventory that is not productive enough.

So you’ve never hurt a business by having too little inventory. You hurt a business by having too much. And so what I will tell you is we’ve got a strong grasp now on the amount of inventory needed to drive quality sales and growth. So it’s hard to compare in this stage because what you will see is our inventories will be down, albeit they will be probably flattish towards the end in our stores, because we have a lot of unproductive inventories, we have a lot of old inventory that was aging and what we have today is fresher, cleaner, more disciplined inventory. When I have the auditor stop me in the hall and give me a high-five, that’s a good sign. So it really is about fresh inventory turning appropriately and so that is exactly where we are headed.

Sean McGuirk - AMICA Mutual

So do you guys feel comfortable, I guess, just looking at inventory today, it’s down 8% year-on-year and [less than 9%] (ph) on a per square-foot basis. Given the spread between your comp, do you feel like you are --?

Tracy Gardner

Absolutely, it feels very comfortable, feel great.

Sean McGuirk - AMICA Mutual

Okay. And I guess --.

Lex Gemas

The quality of that inventory, Sean, is much better. I mean we’re looking at a much higher quality of fresh goods. As we put these processes in place in order to manage the inventory, I think the number I was looking at yesterday was we’re a little over 90% of our merchandise is from March forward versus last year. We were somewhere in the 75% to 80% range of new. So the content of it is also much better, which will in the end deliver us better margin, so, yes, we’re in good situation with the inventories and we manage them very closely to the sales forecast as we go forward.

Sean McGuirk - AMICA Mutual

Can you differentiate against the spread and same-store sales performance of the new stuff versus the old?

Lex Gemas

The sales performance of the old versus the new?

Sean McGuirk - AMICA Mutual

I guess the categories that you guys have been into --.

Tracy Gardner

The newer fresher goods performed better, there’s no question and they turned faster.

Sean McGuirk - AMICA Mutual

You mentioned that sales should continue to see sequential improvement. I was a little surprised of the comp number was a little softer than I was expecting. It seems like you came into the quarter, I guess, with 60% of the inventory or so being the new merchandise and you ended the quarter closer to 85%. It sounds like when should we start seeing the comps starting to improve and I guess also on a two-year stack basis as well?

Tracy Gardner

So like we’ve been saying, we will see sequential improvement from here. I can’t point to the precise time that we will see a comp. Know that we expect that from ourselves for sure and that’s what we’re driving towards. But you will continue to see sequential improvement.

And when you look at the performance of the business in Q3 and Q4 and it really was bottoming out and I think as we reflect -- someone on the last call asked a question or it could have been the call before what surprised us.

I think we were all surprised being new to the business how far down it could go. But that being said, it just makes the ride up a little different. And so again, as I point out to the Q1 performance, what we are super encouraged about is this level of control and predictability and ability to understand what the customer wants and really put the inventories to the current sales trend. Now our job is to healthily grow the business, and we have to clean it up first. It actually it is a messy process in the beginning you’re writing off, you have inventory that’s not performing, you have to win back your customer.

Our experience really had fallen off in the stores. And the good news is our team in the stores is very consistent, they have great love of our brands, they love helping customers. I think the store team has done a brilliant job of finding people who love fashion and who love to be in service. And you will see all that in our stores.

So the first quarter, it really is about expansion of margin and that’s what as investors you want to see. You want to see us expanding margin rates, cleaning up our inventories and gaining control. And from here, you should continue to see sequential improvement if we’re doing our job well.

Operator

That does conclude today’s question-and-answer session. At this time, I’ll turn the conference back over to Tracy Gardner for closing remarks.

Tracy Gardner

Well, I just would like to take this opportunity to thank our team in the DC, in the field, here in headquarters. I’d like to thank our investors. We’ve done a lot of work over the last six months and we’ve been building this business, we’ve been building every process and transforming it. We have been transforming what you see on the web, transforming what you see in the catalog, rebuilding our product engine to create exciting, lovable products at a great price.

And I’m just super, super proud of what this team has accomplished in the last six months. And what I do -- what I can tell you from experience is, from this point the results follow. We’re setting the stage. And it’s been a lot of hard work and passion. And what I’m excited about is how passionate this team is and how dedicated they are to our customer. And I want you to rest assured as investors, we really take the money that you invest in us seriously and we’re going to our best with it. And I just thank everybody for the hard work. Thanks for joining us on the call.

Operator

That does conclude today’s conference. Thank you for your participation.

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