Lands’ End, Inc. (NASDAQ:LE)
Q3 2016 Results Earnings Conference Call
December 01, 2016 08:00 AM ET
Bernie McCracken - Chief Accounting Officer
Jim Gooch - Co-Interim CEO CFO
Joe Boitano - Co-Interim CEO and Chief Merchandising Officer
Steve Marotta - C.L. King & Associates
Mark Rosenkranz - Craig Hallum
Good day, ladies and gentlemen, and welcome to the Lands’ End Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference call is being recorded.
I would now like to turn the conference over to Bernie McCracken, Chief Accounting Officer. Please go ahead.
Good morning and thank you for joining the Lands’ End earnings call for our fiscal third quarter 2016 results. On the call today, you will hear from Jim Gooch, our Co-Interim Chief Executive Officer and Chief Financial Officer and Joe Boitano, our Co-Interim Chief Executive Officer and Chief Merchandising Officer.
After the Company’s prepared remarks, we will conduct a question-and-answer session with our covering analysts. Please note that this morning we released our fiscal third quarter 2016 earnings results, which are now available on landsend.com.
I would like to remind you that today’s discussion will contain forward-looking statements related to future events and expectations. These statements are based on current expectations and the current economic environment or are based on potential opportunities. Actual results may differ materially from those expressed or implied in the forward-looking statements. Factors that could cause the Company’s actual results to differ materially from those discussed are posted in the investors’ information section of landsend.com and in our most recent SEC filings.
Our discussion will also include certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures also can be found in the investor information section of landsend.com. Any reference in our discussion today to EBITDA means adjusted EBITDA as defined in the earnings release. Lastly, we assume no obligation to update the information presented on this call except as required by law.
I will now turn the call over to our Jim Gooch.
Good morning. Thank you for joining us today. I’ll begin the call with the discussion of our near-term priorities and provide operational highlights from the third quarter. Joe will walk you through our key merchandising and marketing initiatives. And then, I’ll review our third quarter financial results in more detail.
As Interim Co-CEO, Joe and I are focused on driving improved near-term financial results while continuing to execute on our long-term objectives. We are clearly disappointed in our third quarter results with sales below our expectations and gross margin pressure from deeper discounting. However, we took steps to ensure that we had clean inventory levels at the end of the quarter while we continued to focus on driving profitability and aggressively managing our cost.
We’ve also evaluated our performance across the organization, drawing from our learnings over the last several quarters to develop a set of initiatives that we believe will position us to deliver improved financial results and better execute our business over the long term.
With these priorities in place, we now have a more focused and cohesive organization, a test to read and react approach to our business, our results oriented marketing plan and a merchandising strategy that reflects the strong brand heritage of Lands’ End and most importantly, alliance with our customer needs.
I’ll now walk you through some of the initiatives we’ve begun to implement, many of which have already yielded improved results. First, in order to drive improved sales performance, we began reallocating our marketing dollars back into our most effective media channels, specifically our catalogs and digital media. In addition to increasing our spend on catalog, we are making refinements that we believe will drive improved conversion among existing customers and reengage lapsed customers.
As part of this, we’ll allocate more catalog pages to easy-to-shop categories selling where we have one or more styles shown in multiple colors and fewer pages devoted to lifestyle presentations. That said, we will maintain a multigenerational family approach, presenting images in a way that better connect with the Lands’ End consumer and her life moment.
We will also highlight value callouts in our cover and our inside pages, which we will clearly communicate a compelling price and value message to all of our consumers. We implemented some of these adjustments into our latest friends and family catalog, and we are pleased to see the strong improvement in performance. Our recent efforts have already driven significant improvement in the number of total buyers, which were positive year-over-year in both September and October.
We are especially encouraged by the reengagement of lapsed buyers where we saw a dramatic reversal in trend from double-digit decreases to a double-digit increase. In addition to the new improvement in existing and lapsed buyers, we are focusing on driving new customer acquisition with more targeted and relevant marketing campaigns in brand appropriate media.
In terms of our promotional cadence, we’ve developed a strategic promotional plan that we believe will create excitement around the brand and drive traffic and conversion. Promotional messaging in both our catalog and on our ecommerce site will be clear and easy for our consumers to understand and act upon.
Specifically, we’ll be testing and refining key placements of the offers in both the books and with our digital spend. In addition, we’ll be working better target our customer groupings in an effort to optimize our promotional offerings. This is something that we are currently testing across all of our channels and will roll out more broadly during the fourth quarter and into 2017.
Turning to our website, we took a deep dive into our performance and identified opportunities to drive an improved sales productivity in the channel. We’ve recently made a number of changes that have already resulted in increased conversion rates.
Our approach to these refinements is methodical as we test, measure, and react to customer responses. For example, we are testing our index sorting to better optimize the customer experience by enhancing the brand esthetic, organizing the product categories by best sellers, and presenting full price items together with markdown products.
We’ve also recently optimized our product page for both mobile and desktop, refined search functionality to be more relevant and made product improvements that are driven by customer data. Finally, now customers can easily shop across Sport, Canvas by Lands’ End, and Classic Collections simultaneously on our website. While these changes are largely tactical, we’ll continue to analyze performance and make refinements in an effort to drive higher conversion and more profitable sales.
In terms of our merchandising strategy, which Joe will speak to in more detail, our ultimate goal is to provide a product assortment that embodies the Lands’ End heritage with the quality workmanship and value that are the hallmarks of the brand. We’re not planning any major shifts in strategic direction. However, we will be placing greater emphasis on our classic business which has been the heart and soul of our brand. As we analyzed our newer offerings, we saw that performance of the Canvas by Lands’ End collection performed well below our expectations and as a result, we incurred a $4.4 million inventory write-down in the third quarter. Furthermore, as we look forward, we’ll be reducing the number of SKUs and inventory investment within our 2017 Canvas by Lands’ End collection.
Finally, turning to our outfitter business, as you may have seen, we recently signed an agreement with Delta Air Lines, which is a tremendous win for us. This new uniform program encompasses both Delta’s above and below wing apparel programs, which means we’ll be creating uniforms for flight attendants and gate agents as well as ground and mechanical crews. We partnered with Zac Posen for the design of the above wing uniforms, and the below wing uniforms will be designed and created entirely by Lands’ End. This new business will have minimal impact until the full launch, currently scheduled for the fourth quarter of 2017.
Overall, we’re pleased to see our initiatives begin to take hold in the back half of the third quarter and into November. But we still have a lot of work in front of us.
With that, I am going to turn the call over to Joe to provide additional color on our merchandising and marketing initiatives.
Thanks, Jim, and good morning, everyone. I am pleased to be here today to discuss our go-forward initiative. As Jim indicated, we have evaluated where the brand is today and in that we’ve developed a well-defined and focused strategy around our merchandising offering.
Our primary focus is on our classic business with our objective being to provide an assortment that reflects our strong brand heritage and addresses the lifestyle needs of our Lands’ End customer. Lands’ End grew from a modest yachting supply company into one of the world’s most recognizable sportswear brand out of an appreciation for well-made stylish products that reflect true American value. However, over recent years, we did not provide the innovation and newness to effectively compete with the best-in-class offerings in the marketplace. We now see an opportunity to regain our best-in-class positioning as we heighten the level of quality, style and value incorporated into our product assortment. To accomplish this, we will focus on the classic product and our core customer by addressing their changing lifestyle needs with new and relevant products.
We’ve recognized that our success is rooted on our ability to deliver an assortment that is exciting and compelling to our customers. We will emphasize categories in which Lands’ End has been known as a destination including outerwear, swimwear and sweaters.
Going forward, our priority is to create a compelling assortment designed to reengage our customer, enable us to regain our strong market position, particularly in key volume driving categories. We will do this by working towards several goals.
First, we need to create a product assortment that is relevant to our core customer and aligns with their lifestyle need. We have long winded destination for classic American sportswear, and we see an opportunity to regain our position in this category. We will focus on heritage items including cotton sweaters, turtleneck, woven shirts, chino trousers and updated style, colors and patterns.
Second, we need to work on improving the quality of our fit across categories, as we recognize, this is important to our customers. Our mission is to create a fit that flatters every body size and makes customers feel great every time they wear our product. Swimwear is an example of a category in which we’ve delivered on this mission with our innovative shape enhancing swimwear offering.
Third, we have the opportunity to enhance the quality of our products with better fabrications and constructions. Consumers are more discriminating than ever and we need to meet if not exceed their standards. For example, we look to incorporate more stretch fabric into our styles to provide better fit and comfort and wear. For seasonal items such as outerwear, we will further emphasize innovation with new fabrics that reflect the latest technology and superior construction.
Fourth, we must do a better job creating newness within our current assortments in key categories while expanding into new categories that are relevant to our brands. We want to drive an increase in frequency of visits to our brand, which means that our customer knows that they will find something new and compelling, as well as relevant to their lifestyle each time they shop our catalog or visit our website. We are focused on doing this with our classic product while also exploring new categories such as Athleisure, which we plan to introduce in late fall 2017.
In summary, our focus is clear. We remain true to heritage and provide a classic assortment with great fit, quality and value. You’ll begin to see these efforts reflected in our spring assortment and fully incorporated into our fall 2017 offering.
In addition to lying out early defined plans for our classic assortment, we’ve also addressed the go-forward strategy for Canvas by Lands’ End collection. As Jim stated, we did not see a strong acceptance of this product line among our existing or new customers. We believe the assortment stayed too far from our classic offering and ultimately confused our customers. Going forward, the line will be significantly scaled back and be more consistent with our classic offering. We will focus on a number of key item categories presenting and elevated and more aspirational offering yet with price points that are still attainable for our customers. A great example of this will be our sweaters. As always, we will offer our classic cotton sweater, which looks and feels great in a variety of colors and styles. But we will also be presenting to our customers the option of an enhanced version under the Lands’ End Canvas line. This line will also service as an opportunity for press and media attention for the brand overall.
In summary, we’ve applied our learnings to adjust our priorities and right size our initiatives in merchandising. We will emphasize businesses that play to our strength, such as outerwear and swimwear categories and scale back in areas that do not fit under the Lands’ End umbrella.
On the marketing side, our guiding principle will follow results oriented strategy. As Jim stated earlier, our catalog is our most powerful marketing tool and we will refocus our marketing spend in this area. This includes upgrading the quality of our books. This is visible in our holiday catalog, which we are extremely proud of. It features the wonderful assortment of gifts with engaging images that has resonated with our customers. In addition, we will effectively leverage social media while also sending direct mails in an effort to engage our customers. Finally, we will select advertising and traditional media, including newspapers and family magazines.
To briefly touch on this holiday season, our strategy was centered around our strong brand heritage, our inclusive spirit and our commitment to quality and value. We emphasize themes such as novelty print flannel pants [ph] across all categories with special emphasis on home and gift giving items including embroidered tote and tableware. We also saw strength in several key item categories including fashion sweaters, turtlenecks and no iron chinos for men. The plaid vest feature on the cover of holiday catalog was highly successful while our Won’t Let You Down Coat, a winner of Oprah’s award was a big hit.
Overall, our product offering was relevant and exciting and garnered strong response from our customers. In short, our priority is continually excite our customer with newness that is relevant to him and her. We believe our initiatives will position us to better engage our customer, win back lapsed customers and attract new customers.
With that, I turn the call back to Jim to review our financial performance for the quarter.
Thank you, Joe. Now, I’ll provide a review of the third quarter financial results. Revenue for the quarter decreased 6.9% to $311.5 million compared to $334.4 million last year. The sales decline was comprised of 5.5% decrease in the direct segment with sales of $272.1 million and 15.6% decrease in the retail segment with sales of $39.3 million. Sales on our outfitter business were relatively flat for the quarter.
Overall, while the first half of the quarter was very difficult from a sales perspective with double-digit declines, we saw significant improvement in our sales trend in the back half of September and October, and over that period sales were relatively flat to last year.
With the exception of our outerwear business, which was soft throughout the quarter due to the continued warm weather, this improvement in trend was across most of our categories with the largest drivers being our women sweaters and bottoms, men’s knit tops and home categories.
The sales decrease in the direct segment was driven by decline in our U.S. direct business as well as our international business. After a slow start to the quarter, sales were positively impacted in September by a successful friends and family event where we saw strong customer response from testing different levels of promotional offers. In October, we increased the depth of the offer, which has helped us begin to rebuild our customer file ahead of the holiday season.
In retail, the sales decline was largely due to 14.3% decrease in same store sales combined with eight fewer Sears locations. We ended the quarter with 219 shops at Sears and have continued to see weak traffic trends within malls and more specifically within our Sears locations. This was partially offset by sales from our new Chicago premium outlet store which opened at the beginning of October as well as our New York Pop-Up location which opened in September and will stay opened through the holiday season.
Gross profit was a $133.7 million compared to $162.4 million in the same period last year. Gross margin declined 570 basis points year-over-year to 42.9%. During the quarter, we wrote down $4.4 million of prior season inventory from our Canvas by Lands’ End brand which contributed 140 basis points to the overall gross margin decline. As I mentioned earlier, our Canvas by Lands’ End product did not perform to expectations. This write-down addresses the entire shortfall in performance of the spring and summer collection.
The direct segment gross profit decreased 17.8% and gross margin in this segment decreased 640 basis points to 42.9%. In the retail segment, gross profit decreased 17.6% and gross margin decreased 110 basis points to 42.9%. Our gross margin rate reflects deeper discounting combined with an unfavorable sales mix, not only within product categories such as outerwear but also between our full price and markdown sales.
Selling and administrative expenses decreased 2.6% to a $132.4 million compared to a $135.9 million in the third quarter of last year. Total S&A expenses as a percentage of revenue increased by a 190 basis points to 42.5%. The decrease in expenses this year was primarily attributable to continued reduction in variable expense, partially offset by an increase in catalog circulation as well as $1.2 million in non-recurring personnel costs, primarily related to the departure of our former Chief Executive Officer.
Operating loss was $3.4 million in compared to operating income of $23.3 million in the third quarter of 2015. Operating loss for the third quarter of 2016 includes the aforementioned $4.4 million inventory write-down as well as the $1.2 million in net non-recurring personnel cost. Income tax benefit for the third quarter was $1.9 million compared to income tax expense of $5.6 million in the same period last year. The effective tax rate was 21% for the third quarter of 2016 which compares to our last year tax rate for 34.2%. The variance in rate is primarily attributable to the effects of credits and other permit differences for the Company. That results in a net loss for the third quarter of $7.2 million or a loss of $0.23 per share compared to net income of $10.7 million or $0.33 per share in the third quarter of last year. Net loss for the third quarter 2016 includes an inventory write-down of $3 million net of taxes as well as non-recurring personnel cost of $0.8 million net of taxes, again primarily related to the departure of our former Chief Executive Officer. For the third quarter, adjusted EBITDA was $1.3 million and that compares to adjusted EBITDA of $26.5 million in the third quarter of 2015.
Now, let’s take a look at the balance sheet. Total cash at the end of the quarter was $135 million compared to $108 million last year. We saw a significant timing shift in our accounts payable with a large portion of payments moving from the end of third quarter last year to the beginning of fourth quarter this year. This accounts for the majority of the increase in our cash balance at the end of the quarter. This shift in payables was directly related to delayed orders and product shipments and this has reversed in November, we expect accounts payable to be more normalized at year-end.
Inventory at the end of the quarter was $425 million, which is $11 million or 2.6% less than third quarter last year. Not only have we reduced our overall inventory investment, but we continue to improve our quality of inventory and we ended the quarter with the cleaner inventory position than at the end of last quarter.
Looking at long-term debt decreased to $491 million as compared to $495 million at this time last year with the reduction due to the quarterly principal payments. Looking at cash used in operations year-to-date in 2016, was $67.3 million, which compares to $94.8 million in 2015. As we look ahead, we’re going to continue to focus on prudently managing our cash while making strategic investments to position the business for long-term growth.
With that, we’re now going to open up the call for questions.
Thank you. [Operator Instructions] And our first question comes from Steve Marotta of C.L. King & Associates. Your line is now open.
I have a couple of questions. First, let’s address flattish sales in late September and October. I assume that’s on a consolidated basis. And you also intimated that is also on an increased promotional activity. Can you talk a little bit about the differential in promotions, maybe from the first part of the quarter to the last part of the quarter and into the current season and overlay that if you will with the inventory and how you define the fact that it’s cleaner even though it is down less than what the sales decrease is?
Yes. First of all, I’ll hit on a couple of those. First, yes, it’s on a consolidated basis. As we said, we were off to a pretty rough start in the first half of the quarter from top-line sales and also we were ending up being a little deep in a couple of spots on inventory. So, we did take a look at our promotional cadence and our promotional depth. We made a couple of changes in the back half to go deeper on some categories and some products, and that absolutely helped us move the needle from top-line sales. However, I would say that it was fairly consistent as we talk about catalogs or as we talk about our spend from a circulation perspective. That wasn’t a significant increase. We did more things digitally, did more things from an email perspective, did more things from a targeted customers perspective that help move the needle in the back half. So, as I look at inventory at the end here, even though it’s not down the same percentage, we are cleaner and we are lower year-over-year. We don’t have any significant issues targeted that might be an issue going into the fourth quarter. So, we feel very comfortable, not only about our dollar volume of inventory but also qualitative of inventory.
Okay. Can you talk a little bit about the promotional cadence? I know you give guidance, but can you talk a little bit about fourth quarter-to-date if it was at what you would consider a similar level to the back half of the last quarter or whether it’s higher or lower?
Yes, as you said, certainly we don’t give guidance, but I’ll give you little bit insight. Overall, promotionally, I think we are consistent with what we’ve said on prior calls that we anticipate the fourth quarter to be fairly flat promotionally and from a catalog perspective year-over-year. I will tell you that we’re pretty happy to see that the overall trends that we saw in the back half of September and into October, we saw many of those continue into November and actually continue into this past weekend around the holidays and it was culminated with one of our better Black Friday and one of our better Cyber Mondays that this Company has seen. So, we do feel comfortable with where we are at. We are doing more test reading, reacting that I mentioned in my prepared remarks. We are listening to the customer; we’re reacting on products and price points where we feel it’s warranted to, to help drive business, focused on driving incremental sales and incremental gross margin dollars.
And one more question as it pertains to your focus on the classics, and you did mention a couple of the categories and you also mentioned being more appropriate, if you will, for your core customer, more amenable to them. Can you define your core customer, age and demographics?
Our current core customer -- it’s Joe Boitano. Our core customer is around 52 years old. She is and he is that customer who likes classic clothes. She is not a fashionista, but she is looking for quality, she is looking for fit, she is looking for sportswear, she is looking for clothes that she feels comfortable with that work into her lifestyle.
And do you expecting that age demographic to remain the same, say for the next year to two to three? I mean for what you’re targeting for what you want to do, do you expect that to remain roughly the same?
Our hope is that we will attract a younger customer through additional new styles and new development of ideas within our product and new offerings.
Thank you. And our next question comes from Mark Rosenkranz of Craig Hallum. Your line is now open.
Hi, good morning. Thanks for taking my questions.
Just kind of high level question. You talked about some of the improvements you saw in total buyers in September and October as well as some of the lapsed buyers. When you look at the kind of revenue headwinds you’ve seen, what are you kind of looking at as the first sizeable improvement? Would it be those kind of returning customers increase traffic or kind of what are you gauging to see the kind of initial signs that the revenue is going to be a sustainable improvement?
I think that that’s a key metric that we look at. We look at the health of our buyer file. And as we said I think on prior calls, we break that between active, lapsed and new customer acquisition. And some of the changes that we made in the back half, as I said, we’ve seen the best results in both the active and the lapsed buyer file that we’ve seen in recent history. New customer acquisition is still trailing a little bit last year but we’ve also seen an improvement in trend. So, as we improve the strength of that buyer file, that will eventually -- it ended up in direct improvement in sales, but that will also give us more momentum going into the fourth quarter.
Okay, great. And then, on the classic side, you plan on a greater emphasis there. What is the kind of split where you kind of thinking and see between the classics and the rest of the business? What level of inventory and sales you think makes up a good percentage related to classics line?
Our classic business should -- will represent about 97% of our total business. It is a major driver of our sales. And as I mentioned in my prepared remarks, Canvas and Sport will be scaled back dramatically.
Okay. Fair enough. That’s helpful. And then last one from me, on the operating expense line, you had some good improvement in the SG&A. What kind of -- you touched on those mostly variable expenses, do you think it’s a reasonable level kind of going forward, this improvement that we’ve been seeing, or do you think there is a little more maybe room for improvement as we go through Q4 and the start of 2017?
I wouldn’t anticipate any dramatic improvement. I think we’ll continue to refine certainly the variable piece. Our biggest pieces of our SG&A, you have a variable piece, you have the marketing piece, you have fixed piece around salaries. And I think we’ve instilled a pretty good cultural DNA around aggressively managing that variable expense, the sales scale up and down. So, you’ll continue to see some movement on there. As I mentioned, the marketing expense should be fairly flat year-over-year. So, I think continuation in the prior trend should be achievable in the fourth quarter.
Thank you. And that concludes our question-and-answer session for today. Ladies and gentlemen, thank you for participating on today’s conference. This does conclude the program and you may all disconnect. Have a great day, everyone.
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