New York & Company, Inc. (NYSE:NWY) Q3 2016 Earnings Conference Call November 30, 2016 4:30 PM ET
Tom Filandro - Managing Director, ICR
Greg Scott - Chief Executive Officer
John Worthington - President and Chief Operating Officer
Sheamus Toal - Executive Vice President and Chief Financial Officer
David Kwon - SunTrust
David Kanen - Kanen Wealth Management
Blair Lambert - Lambert Family Office
Good day and welcome to the New York & Company Third Quarter 2016 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Tom Filandro, Managing Director of ICR. Please go ahead.
Thank you, Angela. Thank you. Good afternoon, everyone. Before we begin, I would like to remind you that some of the comments made on today’s call, either as part of our prepared remarks or in response to your questions, may contain forward-looking statements that are made pursuant to the Safe Harbor provisions in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those projected in such forward-looking statements. Such forward-looking statements are subject to risks and uncertainties as described in the company’s documents filed with the SEC, including the company’s fiscal year 2015 Form 10-K.
And now, I would like to turn the call over to Greg Scott, CEO.
Thank you, Tom. Good afternoon, everyone. With me on the call today are John Worthington, our President, COO and Sheamus Toal, our Executive Vice President and Chief Financial Officer. I will begin with some highlights of our third quarter performance and review the progress we have made against the five strategic priorities we outlined at the start of the year. Then, I will turn the call over to John to review our operational accomplishments in the area of credit and loyalty, eCommerce, store expansion and Project Excellence. Following this, Sheamus will walk you through our financial results in greater detail, then we will open up the call for questions.
For the third quarter, we reported near record product margins, a double-digit increase in eCommerce sales and continued progress toward our five strategic initiatives. Overall, for the third quarter, comparable store sales declined 0.7%. During the quarter, mall traffic declines offset strength in our eCommerce business. Adjusted loss per share was $2.6 million, flat with last year, as increased profit dollars aided by our ADS agreement and reduced product costs combined with reduced SG&A more than offset a modest decline in sales.
During the quarter, our celebrity collaboration with Eva Mendes remained an area of strength for us. We continue to build the Eva Mendes lifestyle, which is resonating well with our customers. Our celebrity sub-brands are achieving our objective to drive awareness and consumer interest in New York & Company as we offer differentiated assortments anchored on a strong fashion and value that can only be purchased at New York & Company.
In addition, our 7th Avenue sub-brand showed improvement in the quarter. Driven by the introduction of the Audrey pant, our wear-to-work pant category comped positively in the third quarter, marking the first time in two years we saw growth in our wear-to-work pants. We have been working hard to improve this area of our business and are pleased to see these results. As you are aware, consumers are loyal to brands that offer great pant fits. We are pleased to be able to deliver on our best at pant fit promise during the quarter and expect to build upon our positive momentum in this category during the holiday season.
In the quarter, we also saw strong performance in dresses, woven tops and accessories, with particular strength in footwear. Outerwear comped positively as well, driven by our assortments which focused on season-less pieces. These successes, however, were offset by weakness in sweaters, impacted by warm weather and in denim, as we did not have a new must-have leg shape to drive sales.
Now, let me take a moment to update you on the five strategic initiatives that we continue to focus on to drive our business forward in 2016. First, we are growing our sub-brands as we evolve into a broader lifestyle brand. As I mentioned, our Eva Mendes sub-brand continued its strong performance. During the quarter, we introduced new product categories, including a broader accessories assortment with a handbag collection launched in September and a partnership with Circa Beauty, which is sold both online and in our Eva Mendes boutique.
In addition, we continued our expansion of our Eva Mendes side-by-side and shop-in-shop concepts to capitalize on the power of this important traffic driver. We currently have 18 side-by-sides, 24 shop-in-shops and 2 standalone locations. In addition, during the third quarter, we saw strong product acceptance in every delivery and held our first-ever fashion show. In Q4, Eva Mendes is the face of the company for a majority of our marketing campaigns and we also launched an exclusive online party collection, which is already performing significantly above plan. We are encouraged by the early success of the overall holiday collection as well.
Our Soho sub-brand positively comped in the quarter, although denim did not meet expectations as we did not have a new leg shape to drive sales. We did see continued success in our Soho Soft Shirt assortment along with the introduction of color in our non-denim bottoms assortment. As we move into Q4, with the introduction of our pull-on legging in both denim and color, we are starting to see an improvement in jeans and in Soho bottoms business.
Finally, as I mentioned, our 7th Avenue sub-brand saw improvement in the third quarter, driven by the introduction of a more modern silhouette in pants catering to our customers’ wear-to-work lifestyle needs. This, combined with the move of our pant event in September from August, which we believe is better timed as it aligns with our customers’ emphasis on wear-now served as a solid catalyst to grow sales in our key pant category during the quarter. This success, however, was offset by weakness in the 7th Avenue sweaters and knit-top. Second, we are continuing to work on creating a deeper emotional connection with our customers and increasing brand awareness among our target. In Q3, we leveraged the star power of Eva and Jennifer to drive new customers into the brand while ensuring that we are connecting with them in ways that are authentic.
To this end, in October, we began a broad initiative celebrating the strength and power of women highlighting strong female leaders across our brand touch points as well as some of our philanthropic partnerships, which resonated well with our consumers. Our celebrity partnerships are a key part of our strategy and we will continue to leverage our celebrities as the face of our Q4 marketing and are excited about the Eva Mendes holiday collection that have had – already had a strong start in November. We have also partnered with the Radio City Rockettes to align our efforts with the famous New York City icon, which symbolizes the energy and excitement of New York City during the holiday period. We believe collaborations like this develop a deeper emotional connection to the brand with our customers.
We continue to attract talent to achieve our long-term sales and profitability goals. We are pleased to announce that Michelle Pearlman joined New York & Company as EVP, eCommerce and Chief Marketing Officer. Michelle has been a New York & Company board member for the past 5 years and has had significant experience in retail, consumer product, marketing and eCommerce with leading retailers, including Ann Taylor. We expect Michelle to add greatly to our strategic marketing, brand and eCommerce initiatives as we work to more closely align our marketing with the interest of our consumer demographic while optimizing the strength of our capabilities in eCommerce and mobile. Michelle brings a unique customer-centric point of view to marketing and eCommerce, which will continue to make our customer our top priority as we move forward.
Our third initiative is focusing on increasing productivity and profitability across all three channels of our business. And we remain focused on ensuring that each channel have the unique yet complementary identity that fits within the overall New York & Company brand halo. John will review this in further detail.
Fourth, we are focused on becoming the best-in-class omni-channel retailer, while simultaneously looking for new channels to broaden our reach, enabling us to better serve our customers no matter where, when or how she prefers to shop New York & Company. We believe that this will also enable us to drive improved performance across the business as we leverage our three distinct channels while adding new ways to provide a seamless customer shopping experience. We have seen strong performance in our eCommerce business largely driven by increases in our mobile commerce sales. Mobile traffic has increased significantly by 45% in the quarter compared to last year. We continue to grow our e-mail files, which will help drive even stronger traffic and sales results to both eCommerce and stores this holiday season. We have made strides in creating a mobile-optimized e-mail experience as roughly 70% of our e-mails are being opened on a mobile device.
Fifth, we continue to make progress in our speed-to-market initiatives in the quarter, delivering products faster to our stores from concept to floor. Within the quarter, we successfully chased several programs, which allowed us to have strong performance in dresses, Eva and Soho blouses. We worked with our agent partners on improving our speed of design and product design by working in new ways. We also made significant progress on the expense side by actualizing savings from Project Excellence in the quarter, which will continue to grow as we move throughout the year. In total, we continue to make progress on our goals despite a challenging environment driven by mall traffic declines, warm weather and distraction of the election.
As we entered the early part of the fourth quarter, we experienced softness in sales. However, we were encouraged to see significant improvement in trend last week as we headed into the critical days of Black Friday and Cyber Monday. Both days, both Black Friday and Cyber Monday, we achieved the highest online sales in our history.
Moving forward, we believe we are poised to benefit as we further identify New York & Company as a key shopping destination for sought after celebrity sub-brand, trend, fit and value right assortment supported by our enhanced ability to connect with our customers through our elevated loyalty program. We expect this, along with our cost and expense saving initiatives, to allow us to deliver on our profit goals in the near-term and well into the future.
Now let me turn the call over to John for an operational update.
Thanks Greg. Our third quarter results were in line with our previous guidance, reflecting improved operating performance versus the prior year third quarter. We continue to benefit from our long-term strategic initiatives. We were especially pleased to generate expansion in gross margin and expense savings, reflecting the benefit of our ADS agreements and savings from our product costs and expense reduction initiatives included in Project Excellence. We were also pleased to see continued strength in our celebrity sub-brands that are only found at New York & Company. This along with increases in our loyalty and PLCC programs have assisted us to mitigate negative mall traffic trends in the quarter. We expect to capitalize on our increasing brand strength to drive sales and profit growth in the final quarter of the year.
I will begin my remarks with a review of our credit loyalty program and omni-channel initiatives. I will then provide an update on our real estate portfolio, outlet conversion, share repurchase and Project Excellence, our productivity initiative. Our credit loyalty market share increased in the quarter to over 44% of sales, up almost 300 basis points over Q3 of 2015. This marks a record for our loyalty credit penetration for New York & Company. We continue to expect growth in our credit card file as we – as well as our e-mail database to drive long-term loyalty and incremental sales. As I have noted previously, our private label credit card customers shop more frequently and spend 2x to 3x more annually. As we continued to increase our credit loyalty penetration, we have the opportunity to more effectively target these loyal customers.
Now let me turn to our omni-channel business. We continued to experience strong double-digit growth in eComm, benefiting from a combination of enhancements we have made and continue to make to our web platform. We believe we continue to lead in technology within the specialty store channel and expect our enhanced capabilities with Ask Us, Ship From Store and Buy Online Pick Up In Store to further differentiate New York & Company from others as we give consumers the flexibility to have the product in the size and color they want and enable them to shop when, where and how they want. We will continue to implement technology enhancements in-store and online. During Q3, we successfully completed our company wide POS upgrade rollout, which includes new registers, scanners and tablets across the entire New York & Company store fleet. The new POS upgrade will help us to better serve consumers across all of our channels. The introduction of tablets in all of our stores will provide mobility and improve overall productivity. The new POS rollout will increase operating system security levels while also supporting further omni-channel growth initiatives. To further expand our omni capabilities and our desire to be best in class, we are on track to testing new New York & Company kiosks in select stores in Q4. This new kiosk will provide a virtual endless isle, offering customers access to all sizes, colors and assortments.
Now, let me briefly provide an update on real estate, outlet conversion, share repurchase and Project Excellence. As we have previously disclosed, we are committed to a comprehensive review of our entire real estate portfolio to improve profitability. In the first nine months of the year, we opened two stores, closed nine and converted 50 lower-volume New York & Company stores to our outlet concept. During the third quarter, we opened a new store in Harlem, New York, closed three New York & Company stores and closed one outlet store. Our converted outlet stores continue to perform well ahead of our comp average with increased profitability, driven by lower rents as well as higher conversion, UPT and traffic.
As we move into 2017, we are expecting to continue our aggressive review of our real estate portfolio to further improve profitability through rent reductions, reposition to more economical locations and closures of underperforming stores. As a result of this comprehensive review, we are now expecting to close 18 stores to 20 stores in the fourth quarter to end the year with approximately 125 outlets and a total of approximately 460 stores. We also continue to operate two Eva Mendes freestanding test stores, one located in Fort Lauderdale, Florida and the other in San Francisco. We will continue to monitor the results of these Eva test stores.
Now let me turn to Project Excellence, which as you know, is our ongoing initiative to improve overall operational efficiency and productivity. As we go through 2016, we continue to see the benefits of our initiatives, which we began implementing last year. Our most significant improvement this year is centered on improving our speed to market and realigning and increasing our collaboration with our key agent partners along with simultaneously driving reductions in our product costs and developing expense controls across all areas of the business. From a speed to market perspective, we have improved our product development calendar and shortened our supply chain timelines. These changes, along with the implementation of a formalized fast-track process, have enabled us to more effectively leverage runway and trend intelligence and more rapidly deliver products from concept to in-store.
Our agent realignment efforts have been successful this year as we continued to increase the relationship between our internal teams. The changes this year have led to an increase in the collaboration and interaction between our design teams in New York with their foreign agent offices, which we expect to assist us to drive margin improvement through improved execution throughout all areas of this product development process. We continue to be pleased with the success of Project Excellence to-date and while we are excited that these savings began flowing through directly to our bottom line in 2016, we still remain very focused on identifying new opportunities to reduce costs, increase our speed to market, increase efficiency and improve profitability.
Now, let me speak briefly about our share repurchase program. In our ongoing commitment to return value to our shareholders, we have invested $1 million to repurchase approximately 423,000 shares of our common stock. At quarter end, we end – we had $4 million available on our share repurchase program. In closing, we managed our business well in a challenging environment in Q3 while positioning our business and brand for improved long-term performance. We remain encouraged that our strategic efforts across credit loyalty, omni-channel, real estate and Project Excellence are beginning to yield top and bottom line results. We remain very focused on delivering both short-term and long-term improvements in sales and profitability for New York & Company.
With that, I would like to turn the call over to Sheamus to review our third quarter results and update our 2016 outlook in greater detail.
Thank you, John. Good afternoon everyone. Net sales for the third quarter were $213.9 million as compared to $219.8 million for the third quarter of last year. Comparable store sales decreased 0.7%, reflecting strength in our growing eCommerce business and $3.1 million of royalty revenue from over new private label credit card agreement, offset by decreases in store sales due to reductions in store count and decreased mall traffic. In the comparable store sales base, average dollar sale per transaction increased by 0.2%, while the number of transactions per average store decreased 1%.
Gross profit, as a percentage of net sales increased by 90 basis points to 29.9% versus last year’s third quarter gross profit rate of 29.0%. This increase reflects $3.1 million of benefits from the new private label credit card agreement, $2.1 million of benefits from Project Excellence through reduced product cost and vendor discounts, partially offset by a 20 basis point decline in leverage of buying and occupancy expenses and $1.3 million increase in shipping costs from the company’s growing eCommerce business.
Selling, general and administrative expenses were $66.1 million as compared to $68.6 million in the prior period. The decrease in selling, general and administrative expenses on a GAAP basis reflects a significant reduction in performance-based compensation expense and the elimination of non-operating charges incurred in the prior year’s third quarter partially offset by an increase in marketing expense due to the shift in classification of $1.4 million of benefit from the private label credit card to revenue and increased variable expenses associated with the growth in eCommerce sales.
On a non-GAAP basis, selling, general and administrative expenses excluding non-operating legal accrual reductions of $0.5 million were $66.6 million. This compares to non-GAAP selling and general and administrative expenses of $66.3 million in the prior period, adjusted for the exclusion of $2.3 million of non-operating charges due primarily to the settlement of a class action lawsuit.
GAAP operating income was $2.1 million as compared to the prior year’s third quarter GAAP operating loss of $4.9 million. On a non-GAAP basis, excluding $0.5 million of non-operating benefit, adjusted loss was $2.6 million compared to the prior year’s non-GAAP operating loss of $2.6 million, which excluded $2.3 million of non-operating charges.
GAAP net loss for the third quarter of fiscal year 2016 was $2.5 million or a loss of $0.04 per diluted share. This compares to the prior year’s GAAP net loss of $5.3 million or a loss of $0.08 per diluted share. Excluding $500,000 of legal accrual reversals, on a non-GAAP basis, the company’s third quarter 2016 adjusted net loss was $0.05 per diluted share as compared to the prior year’s third quarter non-GAAP adjusted net loss of $0.05 per diluted share. Total quarter end inventory decreased 4%, which was below our previous guidance, reflecting lower levels of inventory on hand, partially offset by higher levels of inventory in transit.
Capital spending for the third quarter was $4.1 million as compared to $6.8 million in last year’s third quarter, primarily reflecting continued investment in real estate and IT infrastructure. During the quarter, we opened one New York & Company store and closed 3 New York & Company stores and one outlet store, ending the third quarter with 483 stores, including 130 outlet stores and 2.5 million selling square feet in operation.
The company ended the quarter with $54 million of cash on hand and no outstanding borrowings under its revolving credit facility. As previously disclosed, on January 10, 2017, we expect to receive $22.5 million, representing the second installment of our sign-on bonuses related to our new private label credit card, further increasing our cash balances.
Now, turning to our outlook for the fourth quarter of fiscal year 2016. Net sales are expected to decline in the low single-digit percentage range, reflecting decreased store count partially offset by royalty and other revenue from the new private label credit card agreement and growth in the eCommerce business. Comparable store sales are expected to be flat to down in the low single-digit percentage. Gross margin is expected to be up by approximately 150 basis points to 250 basis points, reflecting benefits from the new private label credit card agreement, reductions in product cost and agent expenses resulting from Project Excellence and reductions in occupancy costs partially offset by increased shipping costs associated with the growing omni-channel business.
Selling, general and administrative expenses on a GAAP basis are expected to increase by approximately 150 basis points to 250 basis points versus the prior year’s fourth quarter, reflecting the combination of re-classes and accrual reversals combined with increased operating costs from the growth portions of our business.
As we have previously discussed, under the new private label credit card agreement, amounts that were classified as reductions of marketing expense are now reflected in sales. This re-class is expected to result in $1.3 million of increases in marketing expenses as compared to last year. As disclosed in the prior year, we reversed certain performance-based compensation accruals on insurance credits, which benefited the prior year’s fourth quarter by approximately $2.9 million, resulting in an increase on a year-over-year comparison with the fourth quarter. However, we did realize benefits in Q3 and prior quarters in the current year, with the annualized full expense down as compared to last year. In addition to the impact of these re-classes and accrual reversals, we are expecting increases in variable selling expenses in our growing eCommerce business and increased investments in digital marketing to drive sales.
Operating results on a GAAP basis for the fourth quarter of 2016 are expected to be approximately breakeven. The company expects total inventory to be approximately flat to the prior year fourth quarter, reflecting mid single-digit percentage increases in on-hand inventory, offset by decreases in in-transit inventory. Capital expenditures for the fourth quarter are projected to be between $7 million and $8 million as compared to $5.8 million of capital expenditures in the fourth quarter of last year. Depreciation expense for the fourth quarter is estimated at $6 million.
With that, I would like to turn the call over to the operator to begin the question-and-answer portion of the call.
Thank you. [Operator Instructions] And we will take our first question from Pam Quintiliano with SunTrust.
Hi, good afternoon. This is Pam on for David – I mean, this is David on for Pam. Thanks for taking our questions. To start off, we had few questions on products.
Hi. What is the current mix of sub-brands as a percent of sales and where could it ultimately go? And with the higher price points, how much more margin upside do these sub-brands offer going forward?
So, our sub-brands represent a large portion of our current business. What’s really not in our sub-brand performance is really our jewelry, our accessory business, our outlet-exclusive business and pretty much our seasonal business of dresses and sweaters. But sub-brands represent a large percentage of our business. In terms of the Eva Mendes sub-brand, which is our largest growing sub-brand, we believe that – we believe we continue – we believe we can grow this business to double its current volume in the next few years. This brand continues to resonate really well with our consumer. And we continue to see great product acceptance delivery after delivery and to continue to expand product category. So, we are excited about what that can be. Also, within Soho jeans, even though in the quarter we did say we positively comped, denim did struggle a bit. However, that was offset by strength in woven tops. I think, as we continue to introduce Soho lounge, I believe we will start to see continued growth in our Soho sub-brand as well. So, as we have always believed, both celebrity and sub-brand represent our two largest opportunities for growth and we continue to see them grow and we are pleased with their performance.
Can you also talk about changes that you are seeing in the silhouette and where your customer is in terms of the adoption of that?
Yes. So, I think what we are definitely seeing is the slim leg and the legging, still a strong silhouette. However, as we move into spring, the wide leg pants, specifically the palazzo and a softer pant in specifically our uptown, wear-to-work 7th Avenue sub-brand, we believe that’s going to be a big push for us. We also believe that tops are getting a little shorter. So, we are definitely seeing a slow move on a silhouette change on the bottom, but as we move into this fourth quarter, what I have seen really from Black Friday on is that the legging business and the tunic business did improve for Black Friday, though I do think we are seeing a change as a shift as we move into spring.
Great, thanks. Can you also discuss the monthly comp progression during the quarter as well as regional performance?
Sheamus, do you want to take that?
Yes, so I will take that. So we don’t typically disclose monthly comps. Obviously, in our commentary for Q4, we did give some sense of the quarter started off for Q4 a little bit softer and then as Greg commented, we experienced significant improvement in the trends last week and in fact, saw some of our best results for Black Friday on our eCommerce business as well as in our core business. So other than kind of that trend in terms of the comps, we don’t typically comment on overall comps by month. Just one additional clarification in my prepared remarks, I commented about our operating loss for the quarter and inadvertently mentioned it as operating income. So the operating loss for the quarter was $2.1 million.
Okay. Thanks. A few more, could you also provide additional details on the comp difference in terms of outlets versus full line and maybe the product margins for your made for outlet product?
Again, we generally don’t breakout the channels, but we have mentioned in our prepared remarks that we continue to see double digit growth in eComm. And we also mentioned that and Greg had mentioned in his remarks that Black Friday and Cyber Monday were at an all-time high, so we continue to have great strength there from that channel. And then the only other comment that I think we made as it relates to channel is that the outlet conversion stores continue to outperform the rest of the racks [ph]. So I think those are the only two we have really ever talked about specifically.
Okay. Thanks for all the answers and good luck for holiday.
[Operator Instructions] And we will move on to David Kanen with Kanen Wealth Management.
Hi, a couple – several questions. How did Jennifer Hudson and Eva Mendes do, was there growth there?
So as I have said in the remarks, Eva Mendes had a very strong quarter. It was our best growing category in the – in Q3, double-digit growth, both online and in stores. We continue to be pleased with that performance and we look forward to holiday with Eva and we look forward to next year as I said earlier. We still believe there is opportunity to even double the Eva Mendes business, based on the success that we are currently seeing. With Jennifer Hudson, I will say holiday will be the last time that Jennifer is with us at New York & Company. She has been a great face to Soho Jeans. We had a great launch with her in early – I am sorry, middle of July to early August. And she definitely is the face of holiday as well as Eva for us. And then we plan to announce a new celebrity sometime in the spring.
Okay. And then geographically, I mean I know it was warm in the Northeast, outside of that, in your other geographies, how did you comp overall?
Again, I think we have mentioned we really don’t breakout by geo, David. But again, we have talked about the two things I just mentioned a minute ago. But beyond that, we really don’t speak about the geo.
Okay. I understand you are trying to sign an agreement with the third celebrity and you are terming out Jennifer Hudson at the end of the year, how did she do, though during Q3, can you give me any color there…?
Yes. I mean as I said, her collection that really – that we launched in late July, early August was good. And I think she, as a face of Soho Jeans, has helped Soho Jeans comp positively quarter-after-quarter. I think Soho Jeans is probably on its maybe sixth to seventh, maybe eighth positive quarter of comp. So Jennifer is the face. And it’s a very different relationship than with Eva. Jennifer’s collection was much smaller and she really was the face of our overall Soho Jeans business.
Okay. And Sheamus, we are going to be closing another 20 stores by year end. We are going to get down to 460, where and when is the benefit, I am sorry, where and when is the benefit in total expenses, I don’t see it, like year-over-year I know the operating loss was an improvement, but if I back out the extraordinary item from a year ago essentially, we lost $2.1 million versus $2.5 million, it was very similar, I don’t see the benefit there, so when and where and to what magnitude will we see any benefit in terms of operating expenses from closing stores?
Yes. So obviously, closing stores, the single largest expense that we have associated with stores is the rent associated and the occupancy related costs associated with the stores. So for us, those occupancy expenses are a component of our cost of sales, so not in our SG&A expense structure. So you do see, as we have been able, over the past few years, to better leverage our buying and occupancy expenses and show improvement in terms of our margins as a result of that, we have seen reductions in that expense. The second largest expense is obviously payroll related, which does end up in our store level expenses and in our SG&A costs. And there, we are seeing benefits of store closing cost. However, they are being offset by variable costs associated with the growth in our eCommerce business. So while we are losing store sales, we are gaining a significant amount of eCommerce sales that come with added variable costs that, within that business, all end up within our SG&A and expense structure. So that’s what you are seeing as in essence, the offset of that. So in terms of the real estate portfolio, we continue to analyze the real estate portfolio in a very aggressive fashion and we will make store closure decisions to improve the profitability of the business. So the store closures that you are referencing in terms of the store closures for this year, I can assure you, we go through a thorough analysis. And for all of those closures, we are – we believe that we are improving the overall profitability of the company by closing those stores. They do obviously, contribute in terms of top line sales growth, but we are analyzing the overall profitability. So while we are losing sales for those stores, we are losing expenses as well and improving the overall profitability. So we will continue that analysis and aggressive approach to it.
Okay. Are – these 20 stores, are these essentially lease ends or is there a cost associated with these exits?
So these are all at natural lease expirations or some of these stores might have been month-to-month stores that we are operating on a short-term basis. But there are absolutely no exit costs associated with any of the stores.
Okay. And then moving to your private label credit card, which seems to be a bright spot, the $22.5 million, when exactly will you be receiving that, that’s I believe, you said – and I read someplace January, I just want to confirm that. And then help me to understand the new royalty agreement and the impact during the quarter, I know it relates just to your credit card sales, but help me to understand that and as it relates to Q3?
David, the second payment comes on January 10 and again it’s $22.5 million. And I will let Sheamus answer the royalty.
Yes. So obviously, the $22.5 million is a significant influx of cash for us. We ended the quarter with $54 million in cash. We traditionally build cash in Q4, so with the $22.5 million, we would expect a significant increase in our cash balances between Q3 and the end of Q4. So obviously, that’s a strong cash position for us and growing. So we are very pleased with the – that component of the agreement in terms of the cash that we were able to generate from the – effectively the sign-on bonuses. The second part of your question, in terms of the royalties, we – in the new agreement, there are stepped increases in the royalties, so we experienced the first step in terms of those increases during this fiscal year. Actually, the larger component of the increases in royalty, occur as we start next year. So, we will even see a larger increase in the royalties as we move into the first quarter of – actually in January of this year. So for fiscal 2017, it will be – the full year impact will be throughout the entire year for 2017 of that increased royalty. As we disclosed in our commentary, in terms of the benefit for this year – or rather for the third quarter, we recorded royalty benefits of approximately $3.1 million that were in sales. So, that was obviously a significant amount for us. In terms of the true incrementality to last year, we are up about $2.2 million in total benefits. In Q3 last year, we obviously had all of the private label credit card benefits as a component of marketing or reduction of marketing expense. There were some carry-forward amounts under the old agreement that did benefit marketing in Q3, but the big increase was obviously within the royalties. We saw $3.1 million recorded as royalties in Q3. When you total everything together under both the old agreement and the new agreement, it represented a $2.2 million increase during the quarter year-over-year.
I think the other thing, David, is Sheamus mentioned the royalty picks up in 2017, so it goes up. But what’s also important to remember and I mentioned it in our remarks is that in Q3, we hit an all-time high of a 44% penetration, up 300 basis points. We have been trending up between 200 and 300 basis points basically every quarter this year. So, we are incredibly focused on getting that number to grow on a consistent basis. And obviously, the royalty is willing to that, so improved profitability as that goes up.
And we will now move on to our last question, which is from Blair Lambert with Lambert Family Office.
Hi, guys. Thanks a lot for taking the call. Just to see if I totally got that right, on the 18 stores that you are closing in the fourth quarter, those are essentially stores that are losing money on a four-wall basis is that what you are saying?
So, they are either stores that are actually losing money or breakeven stores that we have evaluated and don’t believe it’s worth the continued investment. Or in some cases, they maybe profitable stores that are upon lease expiration that the new terms under the lease, they would become loss stores. So, it’s a combination of those three. But the important thing for us is in terms of the future analysis of the impact of those stores, we believe by closing them we are positively impacting the future results, because they are just not hitting our gross profit rates, not hitting our contribution rates. So, they might not all be loss stores, but they are not performing to our expectations.
Okay. And then, just – if I can just kind of run through a few numbers here, I am sorry to do this, but I am just trying to make sure I understand the numbers. So, you have got cash here of $54,000 – $54 million, you’ve got a payment coming in of $22 million, breakeven for the fourth quarter and depreciation and CapEx are close to a wash. So, about somewhere around $75 million of cash at the end of the year before the impact of working capital and you have got a market cap of about $138 million at the end of the day today, so that leaves an enterprise value of about $65 million or so, roughly, I am – you don’t have to tell me if those numbers are alright, but directionally, 65 – around $65 million of enterprise value and you have a valuation allowance, so essentially like a prepaid taxes of about $66 million also. Is that right?
Okay. So – alright, so it’s kind of like the business – you buy the assets and you get the business for free. Just want to see if that’s kind of what’s going on. And you can’t answer that probably, but thank you. That’s helpful.
And that does conclude today’s question-and-answer session. I will now turn the call back over to Mr. Greg Scott for any additional or closing remarks.
Thank you again for joining us. We wish each of you a happy and healthy holiday season and New Year. We look forward to speaking with you when we report our fourth quarter results in March. Thank you.
Ladies and gentlemen, this does conclude today’s conference. We thank you for your participation.
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