Earnings Call Transcript - CURV Q3 2022

Operator, Operator

Greetings, and welcome to Torrid Holdings Third Quarter Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. It is now my pleasure to introduce your host Vince Adams, SVP, Finance. Thank you, Vince. You may begin.

Vince Adams, SVP, Finance

Good afternoon, everyone. Thank you for joining Torrid’s call today to discuss third quarter financial results for 2022, which we released this afternoon and can be found on our website at investors.torrid.com. With me today on the call are Lisa Harper, Chief Executive Officer of Torrid; and Tim Martin, Chief Operating Officer and Chief Financial Officer. Before we get started, I would like to remind you of the company’s Safe Harbor language, which I’m sure you’re familiar with. Management may make forward-looking statements, including guidance and underlying assumptions. Forward-looking statements are based on expectations that involve risks and uncertainties that could cause actual results to differ materially. For further discussion of risks related to our business, see our filings with the SEC. This call will contain non-GAAP financial measures, such as adjusted EBITDA and adjusted EBITDA margin. Reconciliations to these non-GAAP measures to the most comparable GAAP measures are included in the earnings release furnished to the SEC and available on our website. With that, I will turn the call over to Lisa.

Lisa Harper, CEO

Thanks, Vince. Good afternoon, everyone, and thanks for joining us for a discussion of our third quarter results. I'd like to start the call by recognizing the Torrid team for their continued dedication towards the business as we face a choppy macroeconomic backdrop. Despite external pressures, we've remained steadfast in our goal to deliver exceptional product, anchored on our world-class fit. I'd also like to officially introduce Tim Martin, who is joining today's call as our Chief Operating Officer and Chief Financial Officer. Tim brings a wealth of experience to Torrid, and he will be instrumental in helping us deliver on our strategic priorities. I look forward to you learning more about Tim and Torrid as we move forward. Now moving into our third quarter results. Despite the challenging environment in late Q3, our net sales and adjusted EBITDA were within our expectations. During the quarter, we saw the customer respond favorably to new product introductions, including the launch of our Studio line of wear-to-work styles. However, similar to the trends experienced at other retailers, we saw a slowdown in consumer demand during the month of October that coincided with our Torrid Cash event, which typically makes up a large portion of quarterly sales. As a result of this softness, the comparable Torrid Cash event was down double digits versus last year and prior quarters, which negatively impacted performance. As we worked to right-size our inventory levels in the third quarter, we added incremental discounts and promotions, which pressured margins. We were able to make headway clearing through inventory, ending the quarter with total inventory up 25% from last year. While this was a significant improvement relative to the second quarter, it is still somewhat higher than we would like, primarily due to the softer demand we experienced late in the quarter. We are focused on ending the year with clean inventory and expect to be promotional in the fourth quarter to end the year well-positioned for 2023. We continue to work on the priorities that I laid out previously. Key among these was enhancing our promotional and marketing strategies to better balance margin and sales growth. We are still in the test-and-learn stage of our promotional changes and there continues to be significant opportunity for us to improve margins. Elevated inventory levels have limited our ability to pull back heavily on promotions this year. As we move into 2023, we expect inventory levels to be much more balanced, which should enable us to further adjust our promotional strategy with the goal of expanding margin. We have had an opportunity to test different types of margin-enhancing promotions that we will be able to implement more fully next year. In terms of marketing, we are focused on driving customers to store and building the quality and quantity of our customer files. We know that stores are where the majority of new customers first discover and fall in love with our brand, and we view stores as a critical acquisition and engagement vehicle. For example, during the quarter, approximately 30% of the customers shopping in new stores were new to the Torrid brand, and these customers typically spend 25% more in their first year compared to those acquired on the web. Stores and store acquisition is clearly an important strategy of growth for us. In order to build a healthy customer file, we are focused on reengagement of lapsed customers and improving retention. Our marketing efforts to reengage lapsed customers continue to show promise, and we generated another 500 basis point improvement in reactivated customers on top of the improvement seen last quarter. On social media, we're more focused than ever on product. We saw a 160% increase in product conversations versus the prior quarter, largely driven by the success of our Studio collection and the strong reception to the launch. We also executed an influencer campaign last quarter focused on jeans, which highlighted our world-class fit. Customers consistently note that our fit is what compels them to shop at Torrid, and we continue to see low return rates, which speak to the integrity of that fit. Turning to merchandising and products. We introduced new growth categories within the product assortment starting with the launch of the Studio collection in September, which was executed with a full 360-degree integrated marketing campaign that spanned all channels. Given the shift in customer preference for wear-to-work styles, this was the ideal time for the launch. The collection was very strong and drove a 30 percentage point improvement in workwear sales growth versus the prior quarter. We also launched a new collection called Festi that was a nod to the iconic trends that defined the 2000s. This collection featured classic styles, including baby tees and retro graphics, and we saw our most loyal customers respond to the product with a VIP customer penetration that was more than double our typical VIP penetration across other categories. As we moved through the quarter, we offered new fashion and color, including cozy and cold weather products and novelty fabrics and prints. We are encouraged to see her response to new product and we have even more newness slated for the fourth quarter. Our holiday assortment features an expanded breadth of product focusing on glitz, glam, and pretty for all of our holiday occasions. Our most loyal customers respond well to our special collections, and we have many planned for this fourth quarter, including the Retro Chic collection, a new Curve assortment with holiday colors, and we've added another drop of our Betsey Johnson collection. In closing, our team remains focused on making products and operational improvements that will position us to deliver sustainable long-term growth. We're seeing signs that our strategy refinements are working, and we're excited about more product innovation as we continue to capture her interest with relevant fashion and a perfect fitting base. The positive feedback and momentum that we received with our Studio launch are carrying forward into next year as we bring our customer-compelling assortments anchored on an exceptional fit. Our new product launches and seamless customer experience build relevancy with our customer, which would lead to increased visit frequency and higher conversion rates. We are excited about our changes and how they build going into next year. And with that, I'll turn the call over to Tim to provide more detailed financials on the quarter and our updated guidance.

Tim Martin, CFO

Thank you, Lisa, and good afternoon, everyone. I'm incredibly excited to be joining the company as Torrid's Chief Operating Officer and Chief Financial Officer. Torrid is an amazing brand with strong potential, and I look forward to being part of its success. We have a significant opportunity for growth, and I am happy to be working with Lisa and the Torrid team as we strive to consistently deliver on the company's potential. I will begin with a detailed discussion of our financial results followed by an update on our outlook for the rest of the year. Starting with the third quarter results. Net sales came in at the low end of our guidance at $290 million, which was down 5% compared to $306 million last year. Comparable sales in the quarter declined 8% compared to a 14% increase in the third quarter of 2021. As a further comparable, we were up 9% to, 2019. Similar to trends reported at other retailers, we experienced a slowdown during the month of October. This coincided with the timing of our quarterly Torrid Cash event, which negatively impacted our third quarter results. However, we were pleased to see our customer respond favorably to new product offerings during the quarter, including the Studio collection, and demand early in the quarter was more in line with our expectations. Gross profit for the third quarter was $92 million or 31.6% of net sales. This compares to $125 million or 40.9% of net sales in the third quarter of last year. During the quarter, we continued to focus on rightsizing our inventory levels, which resulted in an increase in discounts and promotions over the last year. Approximately, 850 basis points of the decline was due to higher discounts and promotions to clear inventory. The remainder of the decline was inflationary and related to higher product and transportation costs, partially offset by price increases. Selling, general and administrative expenses in the quarter were $59 million compared to $66 million for the third quarter in the prior year. As a percentage of sales, SG&A decreased to 20.4% from 21.7% compared to the third quarter of last year, due to higher private label credit card income and lower performance bonus expense. As a reminder, the terms of our new private label credit card agreement provide a benefit to SG&A expense compared to a year ago. This benefit was partially offset by higher store and web payroll, primarily caused by inflationary pressures, including higher wages. Excluding the benefit from private label credit card income, SG&A as a percentage of sales increased 70 basis points, driven by the deleverage in sales. Marketing expenses in the quarter came in at $13 million compared to $15 million last year. As a percentage of sales, marketing expense was 4.4% and decreased approximately 50 basis points compared to 4.9% in the third quarter of last year. As we navigate a difficult macroeconomic backdrop, we remained disciplined in our marketing investments and made the strategic decision to allocate expenses towards customer reactivation where we are seeing better returns. As a result, we've been able to drive improved spend efficiency versus the prior year. Turning to profitability. Net income for the quarter was $7 million or $0.07 per share compared to a net loss of $59 million or a loss of $0.54 per share for the same period last year. We did not have any adjustments to net income in the third quarter of '22, but for comparison purposes, adjusted net income last year was $28 million or $0.25 per share. In addition to the GAAP measures, we believe that adjusted EBITDA is an important measure that we use to evaluate and manage our business. Adjusted EBITDA came in at the low end of our guidance range at $32 million or 11.1% of net sales. Turning to the balance sheet. Our cash and cash equivalents at the end of the quarter totaled $19 million. Total liquidity at the end of the third quarter, including available credit, was $159.4 million. Total debt at the end of the quarter was $327 million compared to $341 million in the third quarter of 2021. Our net debt to adjusted EBITDA was 1.9 times at quarter end. Inventory at the end of the quarter was $200 million, an increase of 25% compared to $159 million in the prior year. This is a significant improvement compared to the 64% growth at the end of the second quarter. We continue to focus on reducing our inventory levels and expect to clear through any remaining seasonal inventory by the end of the year. While we plan to end the year with inventory up versus last year, it will be clean and comprised mostly of basics and early spring receipts. We opened five stores in the third quarter, including two Curve stores, and we closed three stores. We have opened 14 stores year-to-date. We now plan to open approximately 27 total stores for the year, including eight Curve stores. Turning to the outlook. Given the challenging macroeconomic environment and the volatility in our demand trend, we're updating our outlook for the remainder of the year. For the fourth quarter, we project net sales to be between $285 million and $300 million, and adjusted EBITDA to be between $9 million and $14 million. The outlook for our gross margin rate will remain pressured as we continue to reduce inventory to bring levels in line with demand. For the full year, we are forecasting sales to be between $1.244 billion and $1.259 billion. For the adjusted EBITDA, we are now projecting it to be between $145 million and $150 million. Capital expenditures are projected to be between $27 million and $30 million for fiscal '22, reflecting infrastructure investments and approximately 27 new store openings. We are also planning to close 13 stores this year. In closing, we are facing an uncertain and dynamic environment, and Torrid is certainly not immune to these challenges. While I've only been at the company a short time, I have been impressed with the strength of the Torrid brand, its relationship with the customer, and the Torrid team. I believe we are putting the right strategies and priorities in place to deliver consistent long-term growth. In the near term, we are going to focus on controlling the controllables and setting the company up for success going forward.

Operator, Operator

Thank you. Our first question is from Oliver Chen with Cowen. Please proceed with your question.

Oliver Chen, Analyst

Hi, thanks very much, Lisa and Tim. On the inventory situation now, what are the main strategies to clear through it? And also, is there a risk in terms of the depth of promotions you may need to take? What are you seeing in the consumer environment that gives you conviction you can get through it? As we look ahead to modeling inventory in the new year, would love your take on how you see that in terms of the growth rate relative to sales? And then the second question, Lisa, zooming out, what's your hypothesis for driving greater consistency in terms of what the brand and/or strategies may need to take place for that to happen? And Tim lastly on the debt, what's your target ratio? Would love your refreshment on your priorities in terms of the debt level and the debt to EBITDA ratio you seek to maintain. Thank you very much.

Lisa Harper, CEO

Okay, thanks, Oliver. I'll start with the inventory question. Our aging on our inventory is actually very, very positive, meaning we have very current inventory. There are a lot of moving pieces with inventory, particularly the bulk of inventory that has a long trajectory in terms of clearing is basics, and that's primarily basics in bras and denim and other bottoms. And we are, of course, not promoting that heavily and not burning down that inventory, but we'll land the plane on that and feel comfortable that we can manage that appropriately. The other increase in inventory is actually receiving our spring product in the correct timetable because last year, we considered a resort, which is just setting the stores to be a spring line, and so we count that in our spring inventory. So, we received that on time and we're receiving spring one, which will set the end of December on time as well. And so, last year, those lines were late. So, I'm not worried about the timeliness of managing inventory. We are just very committed to making sure that we stay on top of it and that we turn it quickly. I think actually the opportunity for us is we are much cleaner than we've been all year, and the inventory is very current, and that we can moderate promotions as we move forward. So, I don't actually expect in the first quarter to have to accelerate any more than we have, and I think that we have some possibility of being able to moderate that as we deliver a new product and have the customer respond to that. But overall, with inventory, I'm comfortable with the aging. It's actually quite clean. There are moving pieces associated with it. We're just committed to making sure that we stay on top of it and keep it as current as possible, so that we are not kicking a problem down the road. On my hypothesis for consistency, if I understand what that means, so I've been here a few months and one of the things that we've really focused on, aside from building the right team and building the right operational foundation for the business, is the process for developing our product assortment flow and those assortments by channel. Some of that discipline had been lost over the pandemic time period, and we've reinstated processes that are very straightforward, that are very typical and well-known in this environment, and moving more of our analysis and development earlier in the process, meaning a template for the development and then being able to really test and react more appropriately as we move down the path. So, we've changed the process for development, and we also have reinstated our chase mode in the business, so we're being able to chase as we go into the first quarter and just basically put some core disciplines into place, particularly in assortments by category and by channel, meaning stores versus online assortments. So, I feel very comfortable with the disciplines that we put in place that will help deliver some consistency as we move into spring and throughout the balance of next year, and putting chase back in place, leaving liquidity in our inventory will allow us to react to the customer more appropriately and help build some of that consistency.

Tim Martin, CFO

So, last one over to me. So, Oliver, to also answer a little bit of the question you had on inventory, we believe our guidance appropriately reflects any of the promotional activity we’ll need to do in the fourth quarter to keep that inventory as clean as Lisa mentioned and position us for success going into the first quarter of 2023, which kind of dovetails into the conversation around debt levels. We can generate, as a business, pretty healthy returns on operating cash flows when our working capital and inventory are aligned with sales and demand. As such, we're going to generate a lot of free cash flow in the future of this business. We'll look to invest that in the growth opportunities that we see. We have a significant amount of incremental store opportunities both in Canada and the U.S. that we’ll want to invest in and continue to grow this business at the appropriate times, and we will also look at investing in technology where necessary or other things to bring the customer experience to a higher level. As such, though, we are comfortable with our overall debt level at this point in time and I don't see any need to do anything in the short term to do that. But if we have extra cash flow beyond our investment capability to grow the business, we'll look at doing something at that time.

Oliver Chen, Analyst

Thank you. Happy holidays. Best regards.

Lisa Harper, CEO

Thank you as well.

Tim Martin, CFO

Thank you.

Operator, Operator

Thank you. Our next question is from Dana Telsey with Telsey Advisory Group. Please proceed with your question.

Dana Telsey, Analyst

Hi everyone. Can you expand upon the customer base and the improving retention? Where are you now in terms of retention? How does it look? Does it look different online versus in-store? And can you expand on the product conversion into different categories? It sounds like the Studio collection got a strong response too. What are you seeing in the other categories? And lastly, with the impact of inflation, what are you seeing both on a channel basis and regionally with your core customers? How does it differ? Thank you.

Lisa Harper, CEO

Thank you, Dana. I'll speak generally. We continue to focus on our customer approach, prioritizing new customer acquisition while also emphasizing retention, frequency, and reactivation. Our reactivation campaigns are showing very positive outcomes, and our retention rates are strong. We believe we can improve this by a couple of hundred basis points next year. In addition to retention, we aim to increase frequency. We've observed that each time we launch products like Studio, Festi, or new bra offerings, it engages our core customers significantly and encourages them to return more often. Next year, we plan to execute multiple major launches of new product categories, aimed at driving customer frequency. Regarding new customer acquisition, as mentioned earlier, this will primarily come from store openings, which is the healthiest aspect of our strategy. However, we also plan to drive new customer acquisitions through a digital campaign next year. Overall, we are pleased with our retention efforts, frequency building, and short-term reactivation focus. Next year, we'll maintain a comprehensive approach to growing and enhancing the quality of our customer base. On product conversion, our new products, especially Studio, have been very successful and continue to perform well. I'm pleased with the holiday product offerings, which balance coziness with glam and femininity at the right time. Our stores are looking great, and customers have even asked if we've remodeled, indicating positive feedback on our merchandising assortment. We are seeing favorable responses from both existing and new customers as we introduce relevant fashion products appropriately for the season. This gives us optimism about our product prospects for next year. Regarding inflation, we've noted that in the first quarters of this year, inflation primarily affected our lower household income customers. For the first time in the third quarter, we observed that it also began impacting all customer categories, including upper income levels, which had previously remained unaffected until now.

Dana Telsey, Analyst

Thank you.

Lisa Harper, CEO

Thanks, Dana.

Operator, Operator

Thank you. Our next question is from Lorraine Hutchinson with Bank of America. Please proceed with your question.

Alice Xiao, Analyst

Hi. This is Alice Xiao on for Lorraine Hutchinson. Thanks for taking our question. I had a quick follow-up on Oliver's question. Can you give us a more detailed breakdown of your inventory composition, and just percentages of inventory in each category, whether it's basics, evergreens versus fashion versus things you need to clear? And then secondly, on the upgraded development process you mentioned just now, how much are you leaving open to chase in 1Q versus what you normally would leave open to chase? Thank you.

Tim Martin, CFO

Yes. I'll take the first portion. We don't break out the total detail level of inventory. As Lisa mentioned, what we've seen is we’re the deepest in right now are things that are mostly basics and evergreen categories that we have the time to work through. We are very clean on seasonal and liability products. So, we're confident that we're going to continue to maintain that and that's what we're very much focused on. I'll turn it to you. Do you want the rest of the question?

Lisa Harper, CEO

In the development process, we are allowing for more openness on a liquid basis in order to test and respond. We are also testing products in the third quarter with the intention of reordering them in later quarters. This approach includes a quick turn aspect of liquidity, as well as testing and holding liquidity based on the results from those tests to invest in specific categories. It’s a multi-faceted strategy. I feel confident about the current level of liquidity we have, and our sourcing team is actively seeking ways to improve efficiency and respond more quickly to our successes.

Alice Xiao, Analyst

Thank you. And then lastly, does the updated guidance for sales really assume performance kind of in line with the exit rate? Or are you contemplating any more sort of incremental macroeconomic pressure?

Tim Martin, CFO

I would say that our guidance contemplates a couple of different things. One is the trend that we've seen going through the third quarter, the uncertainty of the overall macroeconomic environment, and our desire to maintain cleanliness in our inventory position and set us up for 2023 that we're pretty optimistic about where our product development as we roll into spring will position us for.

Alice Xiao, Analyst

Thank you.

Operator, Operator

Thank you. Our next question is from Mark Altschwager with Baird. Please proceed with your question.

Amy Teske, Analyst

Hi. This is Amy Teske on for Mark. Thank you for taking our questions. Can you give us any commentary on your Black Friday performance and how that informs your view on the holiday season? And then, with respect to the updated guidance, what are the underlying assumptions that you've baked in for January as you cycle last year's supply chain disruptions?

Tim Martin, CFO

I'll take the first part of the question related to Black Friday. What we did see is, as Lisa mentioned, we are seeing the customer respond to some of the newness. Unfortunately, given our inventory position, we were still very promotional throughout the holiday. We did see actually a pretty surprising and slightly better-than-we-expected response in-store. But I think as Lisa mentioned, the way the new product is resonating in the stores has been well received by the customer. But again, we had to be highly promotional to continue to clear through product. Our January expectations are that the trends that we've been dealing with over the last quarter would retain itself through the holiday, less around the supply chain disruption that really didn't impact us all that much as a comparable benefit. So, we've kind of just assumed basically the current trend of the business will carry forward in our guidance.

Amy Teske, Analyst

Okay. Thank you. And then if I could ask one more. When you're approaching 2023 internally, what scenarios are you baking into your operational planning?

Tim Martin, CFO

We are trying to stay as flexible as possible right now due to the uncertainties in the overall macroeconomic environment. We will continue to focus on keeping our inventory investments aligned with demand trends. As Lisa mentioned, by leaving some leeway in our open-to-buy process, we can adjust our inventory levels as needed in response to demand.

Amy Teske, Analyst

Okay. Thank you.

Tim Martin, CFO

Sure.

Operator, Operator

Thank you. Our next question is from Alex Stratton with Morgan Stanley. Please proceed with your question.

Unidentified Analyst, Analyst

Hi. This is someone on for Alex Stratton. Thank you for taking my question. I was curious about your perspective on the consumer's health. Are you noticing any variations based on income levels? Additionally, are you observing any signs of consumers trading down? Thank you.

Lisa Harper, CEO

In the first half of 2022, we noticed an effect primarily on our lower income customers, which remained consistent. However, for the first time in the third quarter, we observed an impact across all income levels. I don't have the data for the fourth quarter, but we will discuss that at our next call. As I mentioned, the third quarter marked the first instance where we saw effects on all income levels.

Tim Martin, CFO

And then to answer your question about if the customer is trading down, we have not seen them actively trading down when the product is right and they're responding to the newness. We've seen some strong response there regardless of price. However, we have been so highly promotional that our average unit retail is lower than it has been historically. So, she hasn't actually had to trade down.

Unidentified Analyst, Analyst

Thank you.

Operator, Operator

Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for any closing comments.

Lisa Harper, CEO

Thanks, everyone, for joining us on this call. We look forward to returning on the fourth quarter and full year call. And I want to wish everyone a happy holiday season. So, thanks so much.

Tim Martin, CFO

All the best to you and yours.

Operator, Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.