Image source: The Motley Fool.
Lands’ End Inc (NASDAQ:LE)
Q2 2019 Earnings Call
Sep 5, 2019, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day, ladies and gentlemen. And welcome to the Lands’ End Second Quarter 2019 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, this conference call is being recorded.
I would now like to introduce your host for today’s conference Mr. Bernie McCracken, Chief Accounting Officer. Sir, you may begin.
Bernie McCracken — Chief Accounting Officer
Good morning. And thank you for joining the Lands’ End Earnings Call for a discussion of our second quarter fiscal 2019 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. Please also note that the information we’re 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 Reports 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’ll 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.
Jerome Griffith — Chief Executive Officer and President
Thank you, Bernie. Good morning, and thank you for joining us for a review of our second quarter financial and business results. We were pleased to have delivered sales and net income above our expectations, and adjusted EBITDA at the high end of our range, illustrating the strong progress we are making across our strategic initiatives. Based on our results and confidence in the second half, we are reiterating our revenue and increasing our EPS guidance for fiscal 2019.
Our sales increased 5.5%, when adjusted for Sears closures and the lapping of the Delta launch. This growth was led by the ongoing momentum in our global e-commerce business, which grew over 7%. In addition, our US company operated retail stores once again delivered strong comparable sales growth at 7.5%.
As we’ve discussed in the past, our growth strategies are centered on getting the product right, operating as a digitally led company, executing a uni-channel strategy and improving business processes and infrastructure. The progress we’re making across our numerous strategic initiatives continues to put us on track to achieve our stated long term objectives of $1.8 billion to $2 billion in revenue, and high single digit EBITDA margin for fiscal 2022.
Our mission is to deepen our engagement with our core customers and attract new customers to Lands’ End by delivering product with a purpose that offers great value to our customer. We believe our growth will be driven by the continued optimization of our product assortment, as we hone our key item strategy in our destination categories of swim, outerwear, knits and bottoms. We are driving this product strategy through four main objectives that we articulate as own the water, own the weather, layers, layers, layers, and we fit every body.
Our data science department continues to improve our ability to leverage product interest data and product purchase data, which is then applied by our design and merchandising organization to better align our assortment with customer demand and create more productive inventory.
For the second quarter, we were particularly pleased with our bottoms and knit businesses in both women’s and men’s, as we continue to use our data to optimize the assortment mix for our customers. A good illustration of this is in our shorts business, where we saw a big opportunity to expand our offerings with new fabrication. Including No Iron Chino shorts and new linen silhouette, in addition to having more colors and patterns. Our bottoms business also benefited from our hard work around improving our fit as we have learned that providing consistent fit gives our customers confidence to buy online and garners loyalty. In our Denim business, we added 360-degree fabric and shaping along with a variety of washes. Our knit top sell strength across tanks, tees and polos as well as novelty.
We are extremely pleased with the strong response to the enhancements we have made in our merchandising assortments, as we continue to see customer shopping patterns, favorite key items and colors versus full collection. Swimwear saw a slow start to the season, but picked up later in the quarter and continued into the third quarter as we’ve had a better in-stock position as compared to last year. Overall, we will continue to shift the assortment to more closely reflect our customer preferences, which you will see more fully in our fall season.
Looking ahead, we’re excited to be providing an expanded outerwear assortment by adding more variety to our fleece, packable down coats and rainwater offerings. We believe that this, combined with updated looks to our knits and bottoms assortment to ensure our customers enjoy newness, will continue to drive strong results. We also see an opportunity moving forward in swim. The insights gained this quarter in terms of silhouette styles and features position us to strengthen our swim offerings moving forward by increasing our assortment of best sellers and eliminating less popular items.
Regarding our distribution strategy, our goal is to offer our product wherever, however, and whenever our customer wants to shop, whether digitally or in brick and mortar stores. With our heritage of selling clothing online, we continue to lean heavily into e-commerce, which represents over 90% of our direct-to-consumer sales. We are driving new customer acquisitions through digital strategies, investing in digital search to show up when our customers purchase intent is high and the results reinforce that we are making the right steps with our buyer file growing in the mid single digits and new customer acquisition growing in the high teens last quarter through algorithmic targeting of key items to relevant lookalike audiences.
During the quarter, we saw positive results from our continued efforts to capture the digital customer, what she is searching for what she needs. We know our customer has a short consideration to purchase cycle. She is shopping because she wants to buy. So we win when we show up in her search results. As we have seen, our customer who initiated the search is three times more likely to purchase than a customer who does not search. In Q3, we will anniversary the highly successful implementation of our proprietary internal search engine, which fully recoup its cost within the first quarter of this. And we’re guided by what the search data tells us. I’ll share two quick examples to demonstrate these efforts.
First, our internal and external search data from 2018 made it clear that we had an opportunity to sell traditional winter goods such as turtlenecks, cashmere and flannel, well into the spring. We offer these traditionally seasonal products to our customers later in the year. While the target audience is much smaller base than the peak season for these items, we sold several million dollars of counter seasonal merchandise in the second quarter. We’re still testing, are always on assortment.
Second, listening to the digital signals our customer sent. We noted that there would be the opportunity to invest more in warm weather goods such as shorts, tanks and tees in the June, July summer sale time period. Categories such as women shorts saw a triple digit lift in demand during that time period. A clear indication of buy now, wear now is increasingly how the customer chooses to shop.
This past year, we also rode out machine learning-based sorting algorithms. This sorting capability is particularly helpful for customers who prefer to browse rather than search. As mobile traffic continues to grow, we understand just how important a personalized product assortment has become. And we believe that our algorithms, which we continue to fine tune, are contributing to our high conversion rate.
Since we are not restricted by a store footprint, we can give our digital customer her favorite key Lands’ End items whenever she’s ready to purchase. Our efforts around elevating, digital focus resulted in half of our traffic now engaging in Lands’ End on the smartphone. As a result, we continue to invest in our customers smartphone experience, striving for a fast, easy, fun shopping trip, start to finish that will inspire them to come back again and again. We believe these investments in mobile are paying off as we continue to see conversion move along the positive trajectory, countered to everything we hear about mobile conversion challenges within the retail industry.
Currently, our mobile conversion is over 2.5 times the industry average rate of approximately 1.8%. We also know that our digital customers want to shop our brand in retail stores, which is illustrated by the 7.5% comp growth we saw in our company operated stores. We’re very pleased with our retail strategy as our stores showcase our assortment, offer exceptional customer service through highly knowledgeable sales associates and enable us to further engage our customer with the brand.
In addition, our in-store kiosk provides our customers with a gateway to our entire assortment, and our associates are able to recommend selections that are now available in our stores. As an example, we have seen a significant increase in online sales taking place in our stores during this back to school season. Students can try on their school uniform for fit and comfort, then order the appropriate style and size with their school’s logo from our in-store kiosk. And every online purchase made in-store is shipped free of charge from our Wisconsin distribution center.
Our stores also represent a powerful brand marketing tool and we remain very disciplined in how we expand our footprint to leverage our strong brand and heritage. During the second quarter, we opened two stores to end the quarter with 21 US stores. For the remainder of fiscal 2019, we plan to open four more stores to end the year at 25 US locations.
By the end of ’22, we are currently targeting approximately 70 stores in select locations with store economics that generate attractive four wall contribution margins. Our Outfitters business is a key component of our revenue growth strategy, while this business generates some sales volatility due to periodic launches of major programs, it represents a significant long term growth driver for our company.
We remain on track with the American Airlines launch scheduled for the fourth quarter, which will further illustrate our capabilities in the uniform business. We will continue to leverage these and other successful relationships as we strive to grow this business with new and existing partners. Lastly, I will touch on our plans to improve profitability. We continue to believe that as our top line grows, we can scale our SG&A spend appropriately, and accelerate our EBITDA growth to meet our long term EBITDA margin goal. We also see opportunities to reduce overall costs to the benefits of the IT investments we’re making now in our order management and warehouse management projects, and through the realization of greater business process efficiencies. Jim will discuss this in more detail.
We also believe that we can realize greater cost savings by directly managing more of our material spent. To this end, as we announced earlier today, we will be opening our own buying office in Hong Kong later this year. We’ve hired an industry veteran to lead the office, and are excited to move forward. As you may recall, since our separation from Sears, we have utilized the Sears affiliate to provide buying agent services. Our current contract runs through June 2020, and we plan to be fully transitioned by the spring 2020 season.
In conclusion, we remain focused on executing our strategic initiatives. We’re making strides, growing our business and improving our results. We’re excited about our continued growth in our e-commerce business, continued improvement in our buyer file on NCA, and our positive comp store sales in our company operated stores.
With that, I’ll turn it over to Jim to review our financial performance and review our outlook for the third quarter and the full year.
James Gooch — Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer
Thank you, Jerome, and good morning. As Jerome mentioned, we’re pleased to have delivered sales and net income above our expectations and adjusted EBITDA at the high end of our range, despite gross margin pressure. For the second quarter, total company revenue decreased 3.1% to $298.3 million compared to $307.9 million in the same period last year. The decline was due to operating 110 fewer Lands’ End Shops at Sears and counting the impact of Delta Airlines launch from last year.
After adjusting for both, our revenue increased 5.5%. We saw continued strength in our global e-commerce business, which increased 7.3%, as well as significant growth in our company operated stores. We saw solid performance across most of our categories, particularly with strength in knits and bottoms, as we continue to focus on delivering relevant, high quality product at a great value to our customers.
Aligning with revenue, total buyers increase mid single digits with new customers up in the high teens. Online traffic and conversion increased in the second quarter, but in the highly promotional environment, average order value did decline slightly. In our retail business, as expected, with a significant number of Sears store closures, sales decreased from $31.3 million to $14.2 million.
We ended the quarter with 37 Shops at Sears, all of which have leases expiring by the end of this year. We continue to see strong performance in our company operated stores, with a 7.5% comp store sales increase for the quarter. We also opened an additional two new stores and ended the quarter with 21 US company operated stores. We remain very pleased with the performance of our new stores, and plan to open an additional four stores this year. Within Outfitters, our sales declined $7.4 million as the Delta business was down due that copying of the final portion of the launch that were shipped in the prior year second quarter.
This decrease was partially offset by growth in our school uniform business. Looking ahead, we’re making continued progress on our American Airlines launch, which is still being estimated to be between $40 million and $50 million, with the majority expected to occur in the fourth quarter of 2019. Gross margin in second quarter was down approximately 110 basis points to 43.3%. The gross margin decline was primarily related to pricing actions taken in response to additional promotional activity seen throughout the industry.
After a slow start in May, we saw a sequential improvement in June and again in July, which enabled us to exceed our revenue expectations and achieve our profitability plan for the quarter despite the margin pressure. Based on our current trends, we do expect gross margin expansion to resume in the third quarter. Selling and administrative expenses decreased by $6.8 million to $122.3 million, primarily due to the decrease in the number of Sears locations and continued leverage of our cost structure. As a percentage of revenue, we had 90 basis points of improvement as we continue to efficiently manage our variable cost structure, leading to improved scale as we grow the business.
Income tax as a benefit of $3.2 million for the quarter, driven by the favorable treatment of certain foreign entities. Net loss for the quarter was $3 million or $0.09 per share compared to a net loss of $5.3 million or $0.16 per share last year. In addition to the GAAP measures that we outlined above, adjusted EBITDA is an important profitability measure that we use to manage our business internally. For the quarter, adjusted EBITDA was $6.8 million, which was at the high end of our guidance range of $4 million to $7 million.
Turning to the balance sheet, total cash at the end of the quarter was $82.6 million compared to $194.4 million last year. The lower cash balance is a result of voluntary prepayment of $100 million of our term loan. Net long-term debt decreased to $380.6 million compared to $484.4 million last year. Inventories at the end of the quarter were $405.8 million, that’s up $56.2 million compared to the end of the second quarter last year. As you will recall, our efforts last year to tightly manage inventory after a short and critical end of season merchandise. So this year we built our inventory to improve our in-stock levels heading into the spring summer selling season.
In addition, we accelerate shipments to get in front of tariff increases, and to also help mitigate delays that could potentially arise from port congestion. We’re very comfortable with our current inventory levels. They are seasonally appropriate, and we have historically low-aged merchandise. Now, I’d like to spend a few minutes discussing our IT initiatives. We’ve completed our final portion of our ERP roll-out, and we’re now turning our attention to the implementation of our Enterprise Order Management system.
This will provide us with real-time global visibility in our inventory, enabling us to increase our inventory productivity as we improve our ability to offer and fulfill orders through additional internal and external channels. This should result in opportunities for both top line growth and working capital improvement. We’ve also begun to scope out our Warehouse Management System, which would enable us to optimize our package and shipping cost structure, which in turn would drive labor productivity through process improvements and performance management.
Before turning to guidance, I want to take a moment to update you on the recent tariff news. The tariffs most recently announced analysts for are expected to have a gross impact of $8 million to $10 million in the current fiscal year. We anticipate being able to offset approximately 50% of these tariffs through negotiating pricing with our vendor base, passing through some of the costs to our customers, and looking at other savings opportunities in our business. Looking ahead to 2020, we anticipate further reducing our exposure to China to approximately 20% of our total shipments.
As a result, we anticipate our ongoing then [phonetic] impact from the increased tariffs to be approximately $7 million to $9 million per year. Turning to our guidance, for the full year, we continue to expect net revenue to be between $1.45 billion and $1.5 billion, driven by growth in our direct-to-consumer and Outfitters business, combined with nine new store openings. This will be partially offset by the reduction of our Lands’ End Shops at Sears locations.
We are increasing our net income outlook to be between $12 million and $17 million, and diluted earnings per share to be between $0.37 and $0.52. And that’s including the tariff impact that I mentioned earlier. We expect to partially offset these additional costs by reducing the incremental marketing investments that we planned for the second half of 2019. We now expect to spend an incremental $8 million to $10 million as compared to our initial expectations of $10 million to $15 million. These investments will be focused on driving brand awareness and new customer acquisition.
We are maintaining our adjusted EBITDA outlook of $70 million to $80 million. Finally, we expect capex of approximately $40 million, driven by our new Enterprise Order Management system and additional store openings. For the third quarter, we expect net revenue to be between $345 million and $355 million, driven by continued growth in our e-commerce business, offset by the reduction of 89 Shops at Sears compared to last year. We expect net income of $1.5 million to $4 million and diluted earnings per share to be between $0.05 and $0.12. We expect adjusted EBITDA to be in the range of $17 million to $20 million.
And with that, we’ll open up the call for questions.
Operator — Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer
Thank you. [Operator Instructions] Our first question comes from Alex Fuhrman with Craig-Hallum Capital. Your line is now open.
Alex Fuhrman — Analyst
Hey, guys. Thanks for taking my question. And congratulations on a nice quarter here. I wanted to ask about the guidance. Just looking at the results of this year, EBITDA was down good amount here in Q1. It was down slightly in Q2. Looks like based on the guidance, it should be up a little bit here in Q3, and then the implication here in the full year guidance is that Q4 EBITDA should be up quite a bit more than that. So just kind of trying to understand, is that just the natural continuation of the better trends you’ve seen and the increases in the buyer file throughout the year? And just trying to dissect how much of that, which is just that natural improvement that you’ve been seeing versus what you’re expecting to see from the American Airlines launch coming here in the fourth quarter?
Jerome Griffith — Chief Executive Officer and President
Thanks, Alex. Yeah, I think it’s a combination of both of those things. I think you have to remember we have the improving trends. We expect to see those continue into the back half. And then in the first half, we’re comping the Delta Airlines launch and then as you mentioned in the fourth quarter, we’ll pick up the impact from the American Airlines launch. So the combination of all those things I think support our guidance.
Alex Fuhrman — Analyst
Okay. And then just thinking about the swim business, I mean, it sounds like that got off to a little bit of a slower start than you’d expected and then rebounded nicely throughout the season. Do you know anything in particular that was driving that slow start? And, you know, curious, what were you able to do to course correct there and get that business back on track?
James Gooch — Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer
Hi. How you are doing? Yes, swimsuit was sort of a little bit slow in the quarter. Quarter 1 was not terrible. May was really not a great month, partially due to what we had one print that didn’t resonate very well with consumers. But then back into June and then July, we saw swim pick up and it continued to pick up into August. So it was really just a slow start to the quarter, not too much of any changes that we were able to make because we were bought already but just consumer demand picked up as summer went on.
Alex Fuhrman — Analyst
Okay, that’s helpful. And then just thinking about, you know, your other big seasonal categories coming up here in the back half. Outerwear, you know has always been a big category for you. Do you feel you have the right inventory levels for that? And is it, you know, perhaps the expectation that consumers might be purchasing a little bit closer to their actual needs therefore, for outerwear as well?
James Gooch — Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer
Yeah. If you think back to last year, our key item strategy worked extremely well. We did much better in Q3, Q4 in 2018 than 2017. And that really chalked that up to a lot of the key items that we had. Flannel shirts, cashmere sweaters, outerwear and as we go into the back part of 2019, our strategy is really the same. It’s our key items that the customers come and look for. So we think for — we’re bought really well for the holiday season. We’ve put plans in place, which resonate what we’ve learned in the last year. And we feel pretty good about it so far.
Alex Fuhrman — Analyst
Well, that’s great. Thank you very much. And look forward to seeing your holiday assortments.
Jerome Griffith — Chief Executive Officer and President
Thanks, Alex.
James Gooch — Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer
Thanks, Alex. Will talk to you.
Operator — Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer
Thank you. [Operator Instructions] This does conclude today’s question-and-answer session.
[Operator Closing Remarks]
Questions and Answers:
Duration: 25 minutes
Call participants:
Bernie McCracken — Chief Accounting Officer
Jerome Griffith — Chief Executive Officer and President
James Gooch — Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer
Alex Fuhrman — Craig-Hallum Capital Group LLC — Analyst
