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Lands' End Inc (NASDAQ:LE)
Q3 2019 Earnings Call
Dec 3, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Lands' End Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]

I would now like to hand the conference to your speaker today, Bernie McCracken, Chief Accounting Officer. Please go ahead, sir.

Bernie McCracken -- Chief Accounting Officer

Good morning and thank you for joining the Lands' End earnings call for discussion of our third 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. We are very pleased to have delivered both strong earnings growth for the third quarter and a great progress on our strategic initiatives across our businesses. Briefly highlighting our financial results. Revenue increased nearly 5% when adjusted for Sears closures with growth led by our US business. In the US, e-commerce sales grew 7.4%, while our US company operated retail stores once again delivered strong comparable sales growth of 8.3%. Adjusted EBITDA grew nearly 20% to $18.8 million resulting from gross margin expansion of approximately 110 basis points, driven by more disciplined promotional strategies, as well as expense controls.

While we face sales headwinds related to unseasonably warm temperatures earlier in the quarter, we saw an uptick in selling trends, particularly in heavier outerwear as colder weather arrived. The progress we are making across our numerous strategic initiatives continues to put us on track to achieve our long-term financial targets. During the third quarter, we continue to advance our growth strategies, which remain centered on getting the product right, operating as a digitally led company, executing a uni-channel strategy and improving business processes and infrastructure.

Our mission is to deepen our relationships with core customers while attracting new customers to Lands' End. This effort begins with consistently delivering product with purpose, and we are driving our product strategy through four main objectives, own the water, own the weather, layers, layers, layers, and we fit every body. During the third quarter we saw favorable response to newness in our assortment as we increasingly leveraged our data to inform product decisions. We were particularly pleased with the double-digit growth in our knits and sleepwear categories, which represent a meaningful portion of seasonal sales.

We saw strength in our denim and expanded transitional businesses in both men's and women's. Our denim business grew double-digits in the quarter reflecting favorable response to a refreshed and expanded assortment. Our enhanced assortment of transitional products, introduced this fall also resonated with customers. Transitional plays a key role as we look to provide our customer with buy now, wear now product appealing to their personal preferences and shopping habits and reducing reliance on unpredictable seasonal weather. Within this assortment, we saw strength in our new rain coats and in several of our outerwear franchises, squall, 3-in-1, as well as our Thermacheck 100 Fleece. Our sweaters and heavier outerwear businesses while slow through most of the quarter did see a meaningful pickup with the colder more seasonable weather in October.

Entering winter, we will focus on our warmest outerwear adding to successful key franchises, including our expedition collection. These successes tell us that we can drive incremental growth by expanding in categories where we see opportunity. Overall, we will continue to leverage data analytics to more closely align our offering with consumer demand and optimize our assortment.

Across our businesses, we remain focused on maintaining healthy gross margin performance supported by an increasingly AI based promotional and markdown strategy. As we use AI to test and learn, we are gaining traction in driving more effective and profitable promotions and markdowns. We have also improved our price clarity experience where we clearly display the promotional price to our customer, by increasing the visibility for our customer in additional selling channels.

With the combination of dynamic promotions and price clarity, we will continue to evaluate which offers best motivate purchasers, while striking the right balance between sales growth and profitability. We continue to invest in enhancing our mobile experience as we know this is how our customer prefers to shop, especially during the busy holiday season. To this end, we implemented a mobile redesign and reengineering effort during the quarter.

Among the enhancements we made was a 75% reduction in load time on the product detail page, which has already resulted in a significant increase in mobile conversion rates. We have also enabled her to add to her bag more seamlessly and quickly on her smartphone by simplifying the checkout process, which should help to drive higher conversions as well as elevate the customer experience. Currently, our mobile conversion is over 2.5 times the industry average rate of approximately 1.8%.

Turning to our uni-channel strategy. Our goal remains to offer our product wherever, however and whenever our customer wants to shop, whether it be through our digital or physical channels. Our e-commerce channel represents over 90% of direct sales and with our strong heritage we remain committed to building upon our digital capabilities and shopping experience across our business.

We delivered strong US comp growth of 8.3% in our company-operated stores, which play a meaningful role in building brand awareness. Our 2018 openings are comping above expectations reflecting enhancements to our new format. Notably, we are seeing an incremental sales lift beyond the contribution of the new store in a given trade area when we open a store. This supports our continuing retail expansion strategy as this indicates we're gaining brand awareness in addition to opening accretive stores.

We continue to incorporate new learnings across our entire store base. During the third quarter, we opened one store and in November, we opened three additional stores bringing us to 25 US locations. We continue to take a disciplined approach to expanding our footprint in order to best leverage our strong brand heritage and grow brand awareness.

Building on our marketing efforts in the third quarter, we successfully drove high single-digit increase in new customer acquisition through our data driven digital strategies, which make it easy for prospective customers to discover and find products that fit their needs. We continue to build integrated digital campaigns to target prospects that behave like our existing customers. We show up in relevant searches to answer questions like flannel versus fleece pajamas and targeting media, including Facebook and Connected TV smart devices that highlight the benefits of our products. And we use machine learning, auto bidding technology and paid search to win the click at the point of purchase decision.

As we look to build greater connectivity with our customers, we launched a branded Lands' End Visa and private label credit card in October. The card allows customers to enjoy free shipping, 5% reward value on Lands' End purchases and up to 2% reward value at Lands' End on other purchases. We view these benefits as a means to building stronger relationships with our customers and greater loyalty.

Looking at our Outfitters business, we remain on track with our American Airlines launch. We were very pleased with the success of our Delta launch and expect American Airlines to go equally well. We are proud that the largest and second largest airlines in the world have entrusted us with their uniform needs. Longer term, we will continue to pursue new relationships by leveraging these and other partnerships that illustrate our capabilities to execute large-scale national programs. In the school uniform business, we saw a meaningful profitability improvement as we drove higher gross margin.

Turning to the bottom line, we continue to focus on driving profitable top line growth and leveraging SG&A expense to accelerate our EBITDA growth. We see opportunities to reduce costs by leveraging the IT investments we are currently making in areas such as order management, which Jim will discuss in more detail. In conjunction with the headway we are making on our core initiatives, we have been working to expand our business by exploring new growth avenues as we leverage our brands strong heritage. To that end, we would like to provide you with highlights on a few of the opportunities we are pursuing.

First, third-party marketplaces. We believe we can broaden our reach and enhance our growth by expanding our presence to new third-party marketplaces. As you know, we have a presence on Amazon and continue to see approximately 50% of orders coming from new customers. We are working to grow our business with Amazon, as well as expand to new partners that are brand appropriate. Second, we are also looking to selectively enter licensing agreements for products and categories where partners can help us to improve our reach. We see these as opportunities to create new high margin revenue streams, but more importantly as avenues for expanding our brand presence across a broader and relevant audience. And third, we are working on collaborations, as an example, in 2020 we will be introducing a swimwear collaboration with Draper James, Reese Witherspoon's apparel company, which will be offered in both our retail and e-commerce channels in early spring. This is a meaningful branding opportunity as we leverage our product capabilities to drive incremental growth and brand awareness.

While these were in the nascent stages, we are excited by the opportunity to leverage our strong brand and product capabilities to drive growth over the long term. We look forward to updating you on these activities as they progress.

In conclusion, we're excited about the strength in the core business and the progress we continue to make against our strategic initiatives. Before turning it over to Jim, I want to take a moment to share that Lands' End was recently recognized by Newsweek as one of America's Best Customer Service online apparel retailers.

We know that it is important for brands to connect with customers and we believe that we have a strong competitive edge with the brand heritage that Lands' End carries. This combined with our commitment to putting the customer at the center of everything we do creates the foundation for us to deliver consistent profitable growth over the long term.

With that, I will turn the call over to Jim to review our financial performance and review our outlook for our fourth quarter and the full year.

James Gooch -- Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer

Thank you, Jerome and good morning. For the third quarter total company revenue decreased slightly to $340 million compared to $341.6 million in the same period last year. Our performance reflects 89 fewer Lands' End Shops at Sears and a slower start to our heavier outerwear business. After adjusting for the Shops at Sears, our revenue increased 4.7%.

We saw continued strength in our US e-commerce business, which increased 7.4% as well as continued growth in comparable sales at our company-operated stores. While outerwear and cold weather categories were challenged with unseasonably warm weather, we were pleased to see solid performance across many of our categories, particularly with strength in our women's denim and expanded transitional businesses in both men's and women's.

Our sweaters and heavier outerwear business began to improve late in the quarter, with the arrival of colder weather. While we continue to achieve strong growth in new customer acquisition, consistent with our overall performance, total buyers were relatively flat. We again delivered strong performance in our US company-operated stores with an 8.3% comp store increase for the quarter. We're seeing comp improvements across both our legacy stores as well as our newer stores we opened in 2018, which are delivering even stronger performance in their second year.

We also remain pleased with the performance of our new stores. We opened one store in the third quarter and three additional stores in November, giving us 25 US company-operated stores. As we expected with the significant number of Sears store closures, our overall retail sales decreased from $27.8 million to $14.4 million. We ended the quarter with 36 shops at Sears, all of which are in liquidation and have leases expiring this year.

Within Outfitters, our sales increased $1.1 million. In our school uniform business, we made the strategic decision to reduce promotions. While we saw minimal negative impact on sales, we still grew sales for the quarter realizing larger increases in both gross profit dollars and gross margin. We've made significant progress on our American Airlines launch with initial shipments beginning in November. To date, we shipped approximately $20 million of the expected $40 million to $50 million launch. We continue to believe the majority of the launch revenue will be realized in the fourth quarter of 2019.

Gross margin in the third quarter was up approximately 110 basis points to 45.3%. The gross margin increase was primarily related to more disciplined promotional strategies and use of analytics to optimize our markdowns. Based on our current trends, we expect gross margin to once again expand in the fourth quarter.

Selling and administrative expenses were flat due to our planned higher marketing spend, offset by the decrease in the number of Sears locations and continued efficient management of our cost structure.

Income tax was an expense this quarter of $1.3 million compared to $4 million benefit last year. Net income for the quarter was $3.6 million or $0.11 per share compared to a net income of $3.3 million or $0.10 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 $18.8 million, but that's approximately 20% increase versus last year and within our guidance range of $17 million to $20 million.

Turning to the balance sheet. Total cash at the end of the quarter was $15.9 million compared to $105.9 million last year. The lower cash balance combined with our borrowings under the ABL is a direct result of both our voluntary prepayment of $100 million of our term loan and our higher inventory balance compared to last year.

Inventories at the end of the quarter were $499.9 million, that's up $67.9 million compared to the end of the third quarter of last year. The increase was driven by third quarter receipts in preparation for the fourth quarter launch of American Airlines, combined with the decision to accelerate shipments to avoid some of the impact from the tariff increase. We remain very comfortable with our current inventory levels, which are both seasonally appropriate and at historically low aged levels. We expect overall inventories to return to a normalized level by the end of the fourth quarter.

Now I'd like to spend a few minutes discussing our IT initiatives. After the completion of our ERP rollout last quarter, we started to implement our Enterprise Order Management system, which is on plan from both a timing and budget perspective. This quarter we implemented initial phase, which provide a global inventory visibility, we'll deliver subsequent phases in early 2020 which we expect will help increase our inventory productivity and 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.

Before turning to guidance, I want to take a moment to reiterate the impact from the implemented tariffs. We expect the increase in tariffs to have a gross impact of $8 million to $10 million in the current fiscal year. We still anticipate being able to offset approximately 50% of these tariffs through accelerated receipts ahead of the increase, negotiating pricing with the vendor base and looking at other savings opportunities in our business. Looking ahead to 2020 and beyond, we anticipate further reducing our exposure to China to approximately 20% of our total shipments. As a result, we expect our ongoing net impact from the increased tariffs to be approximately $7 million to $9 million per year.

Now turning to our guidance. For the full year, we expect net revenue to be between $1.45 billion and $1.46 billion, tightening our range from our previous guidance of between $1.45 billion to $1.5 billion. However, we are increasing our net income outlook to be between $18 million and $21 million and diluted earnings per share to be between $0.55 and $0.64, which includes the tariff impact that I mentioned earlier. We're also revising our adjusted EBITDA outlook to be between $75 million to $79 million, that's at the high end of our prior guidance.

For the fourth quarter, we expect net revenue to be between $545 million and $555 million, driven by growth in our e-commerce business and our American Airlines launch, partially offset by the reduction of 49 shops at Sears compared to last year. We expect net income of $24 million to $27 million and diluted earnings per share to be between $0.74 and $0.83. We expect adjusted EBITDA in the range of $46 million to $50 million. Finally, we expect capex of approximately $40 million, driven by our new Enterprise Order Management system and additional store openings.

And with that, we'll open up the call for questions.

Jerome Griffith -- Chief Executive Officer and President

Actually Jim. Before we get started with the Q&A, I just want to make one comment because I don't want to get the question about Cyber Week. Keep in mind that Black Friday and Cyber Monday and Tuesday are three of our biggest volume days of the year. Overall, we're very pleased with our performance so far during this busy shopping period, we're still in the middle of it, but we're in line with our expectations.

So now with that, let's open it up for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Steve Marotta with CL King & Associates. Your line is now open.

Steven L. Marotta -- CL King & Associates -- Analyst

Good morning, Jerome and Jim. Congratulations on the quarter. Jerome, just following up with your comment regarding Cyber Monday, I'm assuming, given the weather around the country that the colder weather categories performed well, but maybe you want to peel that onion back one layer on Black Friday through Cyber Monday and the categories that you're most excited about, and even the promotional cadence over the weekend as well?

Jerome Griffith -- Chief Executive Officer and President

Sure. We saw a lot of gift-giving activity actually over the weekend. Big categories have been performing well for us and these should be really no surprise to you. Xxx has been doing extremely well, we were selling over a 1,000 a minute for several hours over the weekend. Personalized Christmas stockings, pajamas, [Indecipherable] had been doing very well, flannel, shirts, we sold a lot of and people have been personalizing lots of product as well. And number one Monogram has been mom. So far number two has been dad. So lots of gift-giving activity.

Cold weather, yeah for sure it helps and we definitely saw that as we were coming into November and yes, it's OK for the weekend, but quite honestly it's the gift giving time of year and that's what we have been selling lot of volume wise.

Steven L. Marotta -- CL King & Associates -- Analyst

I see. Jim, can you talk a little bit about mitigating factors next year for tariffs, are they similar from a vendor concession standpoint. I know that you're obviously moving as fast as you can out of China. From a price increase standpoint, can you talk a little bit about what your expectation is for next year in endeavoring to mitigate the tariff headwind?

James Gooch -- Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer

Yeah, Steve. I think the things that we were able to do this year to help mitigate were a couple of things that you highlighted there. Working with the vendors, but then we were also able to accelerate receipts in front of the tariff increase. Obviously, we don't have that opportunity next year, but next year we are going to continue to look to move volume out of China. As we've said a couple of times now, we're looking at that number being close to 20% of our total shipments next year, which is down significantly from where we were this year and certainly where we've been in prior years.

Steven L. Marotta -- CL King & Associates -- Analyst

Okay. Lastly, Jerome. I think you mentioned leveraging data analytics during the prepared remarks, can you talk a little bit about what analytics you're currently getting now versus a year ago and how you anticipate that will help in markdown cadence and promotional activity and inventory management?

Jerome Griffith -- Chief Executive Officer and President

A couple of things. Part of it is we put tighter [Phonetic] teams together internally and work with our data in order to understand better. What the customer is actually looking for so as we're building the line doing the line plans, trying to make smarter decisions upfront, but the bigger push is really AI based something we call dynamic promo. It's trying to maximize the gross margin and sales volume with all of your items through item numbers and also through colors and sizes. So we've been working and have gone through several cash in this past year, trying to get the algorithms just right in order to maximize price for the customer and maximize our gross margins. We've seen some pretty good headway, so far, and we'll continue to experiment with this going into the coming year, and we think we want to drill down beyond just style and size and color into customer attributes as we run through 2020.

Steven L. Marotta -- CL King & Associates -- Analyst

Helpful. Thank you.

Operator

Thank you. [Operator Instructions] Our next question comes from Alex Fuhrman with Craig-Hallum Capital. Your line is now open.

Alex Fuhrman -- Craig-Hallum -- Analyst

Great, thanks for taking my question. And congratulations on raising the guidance for the year. One thing I wanted to ask about is, you have this nice American Airlines partnership that's about to launch soon. Obviously, that's a very nice piece of revenue as you think about your three-year financial targets, is it necessary that in 2020 there will be another big uniform win in order to grow EBITDA and revenue on top of what you've been able to do for this year? If you could just talk a little bit about how you balance the sort of regular ongoing business with some big new account wins and how those can contribute to getting to that goal?

Jerome Griffith -- Chief Executive Officer and President

I think it's great Alex, that we get these -- lot of confidence from a lot of these larger companies, you think of American and Delta, the largest airlines in the world, we do Chase Bank. So Chase is the largest bank in America. That's great, but those things can be a little bit choppy, particularly around times when you have a launch of new products versus just day in day out business. One of the things we will be concentrating on in the coming year is really our consumer site for our LEO business. There's a lot of small and mid-size businesses out there that we think we have a lot of opportunity in growing and making the site experience a lot more seamless for the customer that comes on there. There's other companies out there, which have been gotten into this business and have grown pretty rapidly and we think that there is market share that we could take if we make the buying experience a lot easier for the customer, particularly when it comes to getting your logo on products.

The other thing that we've been concentrating on and have had predicted good success with in this year has been our school uniform business and managing that at a much less promotional price point. Jim talked about a little bit, where the margins came out, in business Outfitters and we were very pleased with that. It is really one of the things that we're working on over the next two, three years is continuing to pick up our gross margin with how we're managing price points and how we're managing pricing in front of the consumer.

Alex Fuhrman -- Craig-Hallum -- Analyst

Okay, great, thanks. That's really helpful. And then if I could ask also just about the inventory, this looks like the second quarter in a row. It was up pretty significantly and you mentioned the American launches as well as proactively bringing in some products ahead of tariffs. Can you talk a little bit about just the composition of that inventory, do you feel confident that as you work toward more normalized levels at the end of Q4, as you indicated that the composition of that inventory won't be heavily weighted toward any of your seasonal categories?

James Gooch -- Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer

Yeah, I think, first of all we feel very confident in the composition of the inventory. As I said, it's very seasonally appropriate. American Airlines, just the timing of that, we start to take orders, right at the beginning of November and so all of that inventory was sitting in the balances that we discussed with no sales against it at that point in October. So that will normalize during the course of the launch. The tariff was something that we intentionally did and it had sizable cost avoidance against it. We feel that that's also going to normalize by the end of the year. The third piece of it, which is the smallest piece is obviously our top line sales were a little bit soft in the third quarter, but the softness was driven by our colder weather categories and as we mentioned as the weather cool off at the end of the third quarter into the fourth quarter, we started to see a pickup in those categories. And so we still feel very comfortable that by the end of the fourth quarter, we're going to be able to work to a normalized level.

Alex Fuhrman -- Craig-Hallum -- Analyst

Okay, that's very helpful. Thank you.

Operator

[Operator Closing Remarks]

Duration: 27 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

Steven L. Marotta -- CL King & Associates -- Analyst

Alex Fuhrman -- Craig-Hallum -- Analyst

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