Lands' End, Inc. (NASDAQ:LE) Q3 2018 Earnings Conference Call December 6, 2018 8:30 AM ET
Bernie McCracken - Investor Relations
Jerome Griffith - Chief Executive Officer and President
James Gooch - Chief Operating Officer and Chief Financial Officer
Alex Fuhrman - Craig-Hallum Capital
Good day, ladies and gentlemen and welcome to the Lands’ End Third Quarter 2018 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 be given at that time. [Operator Instructions] As a reminder, this conference call maybe recorded.
I would now like to turn the conference over to Bernie McCracken. You may begin.
Good morning, and thank you for joining the Lands’ End earnings call for our third quarter fiscal 2018 results, which we released this morning and can be found on our website landsend.com. On the call today, you will hear from Jerome Griffith, our Chief Executive Officer and President; and Jim Gooch, our Chief Operating Officer and Chief Financial Officer. After the company’s prepared remarks, we will conduct a question-and-answer session with our covering analysts.
Please also note that the information we are about to discuss includes forward-looking statements. Such statements involve risks and uncertainties. The company’s actual results could differ materially from those discussed on this call. Factors that could contribute to such differences include, but are not limited to, those items noted and included in the company’s SEC filings, including our Annual Report on Form 10-K and quarterly report on Form 10-Q.
The forward-looking information that is provided by the company on this call represents the company’s outlook as of today. And we do not undertake any obligation to update forward-looking statements made by us. Subsequent events and developments may cause the company’s outlook to change. During this call, we will be referring to non-GAAP measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures can be found in our earnings release issued earlier today, a copy of which is posted in the Investor Relations section of our website at landsend.com.
With that, I will turn the call over to Jerome Griffith.
Thank you, Bernie, and thank you, everyone, for joining us today. Overall, we are very pleased with our third quarter results, which marked the sixth consecutive quarter of sales growth and the sixth consecutive quarter of adjusted EBITDA increases. Briefly touching on our results, for the third quarter, revenue grew approximately 5% over last year to $341.6 million and adjusted EBITDA increased approximately 22% to $15.7 million.
We saw accelerated growth in our Direct segment, which grew approximately 8% as compared to last year. We were particularly excited to see that the growth was led by the strength in our US e-Commerce business, which grew in double-digits. Within our Retail segment, comparable sales grew by nearly 12%, led by our U.S. company-operated stores, which recorded same store sales of plus 15% to last year. Gross margin expanded approximately 60 basis points in the third quarter, and we are very well positioned with both the level and content of our inventory as we head into the holiday season.
We’re extremely pleased to see the momentum across our business continues through The Thanksgiving and Cyber Monday period. At the beginning of the year, I said that in 2018, we will focus on building momentum through four major growth initiatives: number one, product, to focus on key high quality items that offer great value to our customers; number two, digital, to transform into a quicker and more nimble digitally led organization; number three, distribution, to engage our customer wherever, whenever they want to shop. And finally, number four, business process, to build strategic competencies through improved business processes that are based on standardization and efficiency. We’ve been working diligently on advancing these initiatives, and I’m extremely pleased with the traction we’re gaining across all areas. I’ll touch on product, digital and distribution and Jim will update you on business process.
Beginning with the product, we have talked about providing a relevant assortment that reflects our American Heritage combined with innovation. Our focus has been to deliver style, quality, comfort and value with emphasis on key categories. During the quarter, we saw exceptional performance in outerwear, knit tops, denim, flannel and home. In fact, we had one of our strongest quarters in recent memory in our knit business with some new progress, including novelties, which represented incremental business growth. On our last call, I spoke about how we made a bigger push into early fall outerwear with transitional fabrics, including ultralight down and fleece in the silhouettes.
Within transitional outerwear, we made a big investment in women’s fleece, which exceeded our expectations, particularly in sweater fleece and Sherpa fleece styles. These product wins reflect our effort to leverage our data analytics, to support design and creating new products in the fabrics, silhouettes and price points that drive purchasing behavior. This is clearly paying off. Collectively, our initiatives contributed to the strong growth in outerwear sales in the third quarter reflecting double-digit gains in every business area within this category.
We’re seeing the strong trend continue into our heavier weight down and squall outerwear. These styles which were building momentum through the third quarter as the weather became colder are resonating with customers, and we expect to see continued strength through the remainder of the fourth quarter.
We are also very pleased with how we are positioned for the holiday season. For our sweater business, we applied data analytics to develop new styles using proven fabrications and price points. We are encouraged by the early favorable response. We are also seeing strong results in some favorite gift categories such as sleepwear and personalized Christmas stocking in addition to holiday bedding.
Turning to digital, we continue to focus our initiatives on new customer acquisition and an improved customer experience. To drive these initiatives forward, we are increasing our marketing investment for the remainder of the year and all of 2019. We remain pleased with the continued strong growth in the customer file, driven by improvements in Levi [ph] rates and an increase in new customers. We have also ramped up our efforts to deliver segmented and personalized emails by leveraging our data.
Our digital investments in landsend.com are also yielding benefits. During the third quarter, we devoted substantial attention to improving the customers' experience and time for holiday peak. We improved our internal search engine and implemented price clarity across all platforms to better capture customers during their discovery phase. We enhanced our site with best-in-class external search engine optimization practices, including updated product description that align with the language and habits that our customers use when searching for product. We also enhanced our smartphone experience as this is the device our customer increasingly prefers. Like [Technical Difficulty] great smartphone to customer experience with compelling merchandized and increased price clarity in a way that's quick and easy to shop. We drove significant improvement in traffic and realized double-digit conversion increases year-over-year in the third quarter, in terms of our business year-over-year in the third quarter.
In terms of our distribution strategy, we remain focused on developing a unichannel approach, ensuring that customers have the same great experience wherever, whenever, and however they choose to purchase our products whether through our own website, our own retail stores, third-party e-commerce platforms like Amazon or through our own call center.
Turning to our retail business, Jim will discuss the recent developments with regard to Sears in more detail. But I'd like to emphasize that Sears has not been part of our long-term growth strategy, and we have been planning that business down for some time. As Sears has continued to close locations, we have been executing on our own retail strategy and expanding our own store base. While building a retail store network will take time, effort and resources, I believe we have a viable, profitable and expandable store model, which complements our successful online presence with brand-appropriate, single-brand focused, Land's End staffed and operated bricks-and-mortar locations.
We have been extremely pleased with our retail rollout so far. Our new stores are another example of how we have tested different approaches and have used the learnings from our test to improve each new store. We're testing types of locations, finding which center characteristics our customers are attracted to as well as merchandize offerings among our women's, men's, kid's, school and home offerings.
Our last two store openings, Chimney Rock and Bergen County, which have benefitted from our learnings, have yielded our best results and are now turning to be two of our largest volume stores. Our stores represent the Land's End American Heritage aesthetic making it easy for customers to find our customers and then inviting brand appropriate setting, while also enabling us to better engage and connect with our customers. These stores allow our customers to interact with the products and brand for fit and feel, speak for their knowledgeable sales associates about product features and benefits, and get assistance to find just the right item either on the floor or through our in-store web portal, which exposes them to our full range of offerings.
We have an extremely loyal customer base, who are excited to visit us in convenient locations and see their favorites with just the right amount of newness. We're getting valuable feedback from our customers on which categories they want to see in our stores and adjusting our assortments accordingly. We opened five of our owned stores this year and will end the year with a total of 16 stores in the U.S. Looking ahead, we planned to continue to expand our own retail footprint and expect to almost double our current store count with the open to have another 10 to 15 stores next year.
While we are making it easier than ever to shop through our own website, landsend.com, we see tremendous potential to increase brand awareness and expand our customer-reach by selling Land's End products on third-party marketplaces in the U.S. and internationally. For example, we've recognized that half of apparel searches now start on Amazon, and as you know, we began selling key items on Amazon in February. Approximately half of our Amazon customers are completely new to our brand. In general, the Amazon customer looks similar to the Land’s End customer, and the key items that are selling well on Amazon are the same key items that are selling well through our own website and retail channel. Clearly, customers are reacting positively to our key item product strategy across our channels.
In summary, I’m proud of the accomplishments we have made as a team and I'm highly encouraged by the progress we’re making throughout the business. We remain focused on executing our strategic initiatives and believe we are well positioned to meet our long-term goals. With that, I’m going to turn it over to Jim to review our business and financial results in more detail.
Thank you, Jerome, and good morning. We’re very pleased with the continued progress that we’ve made in the third quarter. We drove our revenue growth, gross margin expansion and continued to leverage SG&A as a percent of sales. Before I get into the third quarter results, I’d like to spend a moment discussing the recent development with Sears. As part of our long-term growth strategy, we’ve been taking steps to mitigate any potential impact of closing our Lands' End shops at Sears. We firmly believe that we are well positioned to meet our customers' needs through our unichannel distribution model represented by our website, catalogs and standalone retail stores.
Our current plan is to open 50 to 60 of our own retail stores over the next four years, which we believe, will make up for the last sales at Sears. At the end of the third quarter, we had 125 Lands' End shops at Sears. Currently 43 of those locations have been identified as closing and an additional 33 shops have leases that expire at the end of fiscal 2018. As a result, we expect to end the year with no more than 49 plans and shops at Sears.
We reproject our revenue from these locations to be approximately $100 million for fiscal 2018, and based on the remaining 49 stores, we forecasted approximately $30 million for fiscal 2019. While we cannot predict what will happen with Sears, we estimate the closure of these stores collectively will have very little impact to our earnings on an annual basis.
Turning to our third quarter results, revenue increased 4.9% to $341.6 million compared to $325.5 million in the same period last year. In our Direct segment, sales grew 8.1% to $313.8 million. In our Retail segment, comps increased 11.8%, while overall sales decreased 21% to $27.8 million due to Sears store closures.
Within the Direct segment, we saw a double-digit increase in our U.S. e-commerce business and a low single-digit increase in our Lands' End outfitter business. The U.S. e-commerce business was led by outerwear, knit tops, denim, flannel, and home while the outfitter business was led by growth in our national business accounts. As a reminder, our initial shipping period for Delta ended in the second quarter, and we expect to see minimal incremental revenue from Delta into the second quarter of 2019.
As far as an update on our American Airlines launch, the teams are currently working through the wear testing and product development is on schedule. We continue to expect this launch to take place in the fourth quarter of 2019, and we’ll update you as we progress. The American Airlines launch will be approximately two-thirds of the size of the Delta launch with all of the revenue projected to occur in the fourth quarter of 2019.
In our Retail segment, our U.S. company-operated stores delivered comparable sales growth of 15.1% as we saw customers' response very favorably to our seasonal product assortments, specifically around outerwear, flannel and knit tops.
At our Sears locations, comps increased 11.7%, driven by strong sales volume in liquidating stores. At the end of the third quarter, we had 63 fewer shops to Sears compared to last year. We also ended the quarter with 16 U.S. company-operated stores. As Jerome mentioned, we are very pleased with the performance of our new stores and planned to open an additional 10 to 15 stores next year.
Gross margin in the third quarter increased approximately 60 basis points to 44.2% and gross profit dollars increased 6.3% to $151 million. Overall, gross margin improvement was driven by a 570-basis-point increase in the Retail segment, partially offset by a 20-basis-point decrease in the Direct segment. The strengthened retail was a result of favorable full price selling mix, greater promotional productivity, and improved quality of seasonal inventory, which led to higher sell-through and reduced markdowns. The decrease in the Direct segment was from higher shipping costs during the quarter. As we look to the fourth quarter, we continue to expect margins to improve, as we drive promotional productivity and continue to manage our seasonal markdowns.
Selling and administrative expenses increased $6.2 million to $135.3 million, primarily due to an increase in marketing expense, combined with personnel costs and incentive accruals. SG&A as a percentage of revenue improved by approximately 10 basis points. With the improvement in our product and e-commerce capabilities, we planned to continue to invest in marketing for the remainder of 2018, and all of 2019, as part of our long-term strategy to drive brand awareness and new customer acquisition.
Specifically, we planned to spend an incremental $10 million to $15 million in 2019 compared to 2018. In addition, based on our improved performance, we also expect to record higher incentive accruals in the fourth quarter compared to last year. Depreciation increased by approximately $1 million to $7.4 million, largely due to our multi-year ERP implementation. The income tax benefit was $4 million for the third quarter of 2018 compared to an insignificant amount in the third quarter for 2017. The higher benefit is primarily due to revised estimates of the impact due to the Tax Act. Net income for the quarter was $3.3 million or $0.10 per share compared to net income of $0.2 million or $0.01 per share last year.
In addition to the GAAP measures that we outlined above, adjusted EBITDA is an important profitability measure that we used to manage our business certainly. For the quarter, adjusted EBITDA increased approximately 22.1% to $15.7 million versus $12.9 million last year.
Turning to the balance sheet, total cash at the end of the quarter was $105.9 million compared to $92.9 million last year. Our $35.6 million improvement in operating cash flow, in the third quarter, was a direct result of effective management of seasonal inventory and continued progress in reducing lead times to improve inventory flow, partially offset by inventory to support our Delta Airlines business. Inventory at the end of the quarter was $432 million. That's up $8.4 million or 2% compared to the end of the third quarter last year.
Importantly, the overall health of our inventory is very strong. Our aged inventory is the lowest that's been in recent history and we have depth and key items to drive sales over the holidays. Net long-term debt decreased to $483.4 million compared to $487.2 million at this time last year, with the reduction during the quarterly principle payments.
We expect CapEx to be approximately $40 million for 2018. We’re very pleased with the successful implementation of our ERP system and the business process efficiencies that it's providing. We’re on track to complete this rollout early next year fairly close to on time and on budget.
Looking ahead, we’ll be shifting our capital dollars to new projects such as order management and warehouse management systems in addition to the opening of 10 to 15 new stores in fiscal 2019. These system implementations combined with business process improvements across all segments are key enablers to us achieving our long-term financial targets. We will update you on our CapEx plans for next year during our fourth quarter call.
Given the increased stability and visibility in our business, we plan to reinstitute guidance beginning in fiscal 2019. We’ll provide you with those guidance metrics on our fourth quarter call. In addition, today, we are providing some guidance around depreciation and interest expense for the fourth quarter of 2018. We expect D&A and interest expense to each be approximately $8 million for the quarter.
And with that, we’ll open up the call for questions.
[Operator Instructions] Our first question comes from the line of Alex Fuhrman of Craig-Hallum. Your line is now open.
I wanted to ask about the store strategy. It seems like you're obviously pleased with the results you’re seeing from the new stores, you’ve been opening. And on the other side of the coin, the legacy source that you’ve operated for years, your inlet stores really appeared to be performing well with such a strong same store sales increase. I’m wondering if you can talk about, I guess the difference between the two classes of stores is that your hope overtime say perhaps make the inlet stores look a little bit more like the new format of the stores? Or as you eventually open 40, 50 of your full price retails stores, should we expect to see your inlet stores kind of performing more of that outlet store function overtime?
Thanks for the question. I would say that the legacy stores that have been around for several years, they have always performed in a certain way and they were source-stocked in a certain way. I think as we continue to open up new stores and think of new ways to run retail businesses here and tie that inlet with more of an omnichannel presence, we’re shipping differently, we’re setting the stores up differently, we’re carrying different assortments in the stores and it's kind of resonating with the consumer. How many pieces we have per square foot? What our key items strategy looks like? Number of skews we put in the store continues to evolve and customers actually reacting pretty well to it. The order stores -- many of them are located in pretty decent locations. So as the leases come up and time maybe right if they're favorable economic terms, we will probably re-up those stores and go to new leases. So we’re generally happy with the performance of the older stores and extremely happy with the performance of the newer stores. The last couple that we’ve opened up that shut up to be top-volume stores for us and about half of the space of what the legacy stores are using. So we’re pretty happy.
That’s great. And can you give us a better sense of -- as the Sears business gets wind down overtime, can you give us a sense of what’s been sold in those stores? I mean, it’s -- often it looks like its different merchandize, and we see on landsend.com or in your Lands' End company operated stores, there is very risk that you’re going to lose some production efficiencies as those stores wind down or that perhaps there is merchandize being cleared through those stores that might need to be cleared through other channels?
Yes, actually, Alex, it's the same inventory in the Sears locations that you see on our site. Yes, sometimes we've used it to liquidate through some clearance merchandize, but we also do that in our older locations and our own company-operated stores too. So I don't see any risk at all when we exit those locations that it would create some form of an inventory problem.
Thank you. And I'm showing no further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone have a great day.