Earnings Call Transcript - LE Q3 2023

Operator, Operator

Good day, everyone and welcome to the Lands’ End Third Quarter Earnings Conference Call. Please note today’s call will be recorded, and I’ll be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Bernie McCracken, Chief Financial Officer. Please go ahead.

Bernie McCracken, CFO

Good morning and thank you for joining the Lands’ End earnings call for a discussion of our third quarter 2023 results, which we released this morning and can be found on our website, landsend.com. I am Bernie McCracken, Lands’ End’s Chief Financial Officer and I am pleased to join you today with Andrew McLean, our Chief Executive Officer. After the prepared remarks, we will conduct a question-and-answer session. 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 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 Andrew.

Andrew McLean, CEO

Thank you, Bernie. Good morning and thank you for joining us today. Before I turn to our Q3 results, I’d like to congratulate Bernie on his appointment to Chief Financial Officer, which we announced in September after having served as our interim CFO since January. I couldn’t be more pleased to continue working with Bernie and I am more than confident that he will continue to lead our financial organization with excellence. With that, I’ll turn to our Q3 performance. Our results were characterized by strong execution of our solutions-based strategy to deliver quality for our customers and value to our shareholders. We built on our momentum from Q2, further improved our inventory position, injected newness across our assortment and continued to prioritize gross margin improvement to drive incremental gross profit dollars. Our deliberate strategy to improve development of our solution-driven products generated more profitable sales, resulting in gross margin and profit expansion and adjusted EBITDA of $17 million above the high end of our guidance range. As I have previously noted, we are executing a deliberate strategy to drive higher quality sales with a larger portion of our sales occurring with no or lower levels of promotions rather than simply prioritizing moving units so we can enhance gross margin and deliver increased cash flows. Paired with our work to further improve our inventory position, it’s clear this strategy is working. Q3 marked our third successive quarter of significant inventory and margin improvement, with a 25% reduction and 700 basis points of improvement respectively. We are confident that we have found a winning formula, increasing churns of merchandise while maintaining lower, more efficient inventory due to our targeted customer cohorts. We are taking advantage of the flexibility that our lower inventory levels provide to continuously refresh our assortment with new styles, cards and fabrics more frequently throughout the year. Our customers are responding exceptionally well to this approach. As we introduced last quarter, we transitioned from a demographic focus to a capability focus when it comes to our customers. We are zeroing in on two key high-value customer cohorts, which we call our resolvers and our evolvers, and leveraging our proprietary data to better understand their shopping behaviors. As every month, resolvers are the largest cohort of our existing base. Their solutions focus addresses that prefer classic styles and value quality over trends and shop primarily out of necessity 2 to 3 times a year. Evolvers are our second largest cohort as an opportunity for growth. They are discovering and refining their style in an ongoing journey, wearing what fits their current lifestyle. They generally have more buying potential and spend more than resolvers. As part of our identity as a solutions company, we are changing the way we think about our assortment and marketing strategy and aligning them more closely to how our key cohorts shop. We are creating a more compelling customer journey that provides a more holistic look and builds the Lands’ End iconic American brand and the way we design, present and sell our products. We are taking a more outfit-centric approach to our assortment and go-to-market strategy designing and prioritizing products across categories that feature significantly more productive inventory and facilitate sales across natural adjacencies. You can see this in how we are showing up in digital and with the look and feel of our website and marketing. As a digitally native company, we are using this new approach alongside our investors to drive more robust engagement with our key cohorts. We are continuing to improve our site experience for more targeted marketing to present our customers with relevant and engaging content to drive quality sales. As a result, we have seen increased traffic and engagement from social media and with repeat exposure we expect our social media prospects to continue growing nicely. On the heels of strategic infrastructure enhancements we have made to improve our internal efficiency, we have begun to maintain our IT focus to enhance our customer-facing processes. We recently welcomed a new technology leader who has been spearheading efforts to work with me to roadmap our strategy and identify leading partners to drive innovation consistent with our asset-light model. Our authority in outerwear solutions was a key driver of our strong performance this quarter, both in the U.S. and internationally. We drove sales in key adjacencies, especially bottoms and sweaters, where new styles in key fabrics like corduroy, denim and velvet, and new colors contributed to the strong performance. Of note, demand in nearly all our women’s categories were up double digits in our U.S. e-commerce business. Our swim solutions finished the summer strong in August and we are looking forward to building on that success with the introduction of our upcoming spring swim assortment, which includes a recommitment to the one-piece category with the creation of our product family centered around our classic topless solution and the enhancement of control-based technologies, including a shaping technology that we have protected via a patent application. Swim remains an incredibly innovative space for Lands’ End to expand and develop. Building on the theme we discussed before, our customers are responding positively to freshness across categories. This is contributing to strong performance in our layering products and transitional outerwear solutions, which gives us confidence that we will be able to continue this trajectory more consistently in the months and years ahead. Our U.S. e-commerce business, our largest direct-to-consumer channel, delivered a second consecutive quarter of great margin performance due to our more targeted approach to promotions and improved inventory management. When we offer our customers the solutions they need in a relevant presentation with attractive fabrications, color and value, they are responding and not necessarily waiting for discounts at the level we have had in recent years. We are also continuing our efforts to maximize key events to drive demand with our customers responding well. Our more constant promotional strategy, which complements our broader strategy to minimize markdowns and shows conviction in our solutions-based categories, has led to improved margins. Turning to our international business. As with our U.S. business, our strong performance was driven by our authorities in transitional outerwear solutions. Thanks to prioritizing newness and improved inventory management, we delivered margins that were in line with our U.S. business. Gross margin in Europe grew nicely by approximately 1,000 basis points year-over-year. During the third quarter, we continued executing on our licensing strategy, which adds royalty guarantees and new income streams, allowing us to continue to focus on our core capabilities. Recently, we entered into a licensing agreement for all kids categories and we are continuing to ramp up activities under our existing agreements with Costco. And as I mentioned on our last call for footwear, we expect to begin seeing income from three licenses in 2024. Moving forward, we expect to maintain our expanded focus on licensing and are continuing to build a robust pipeline of potential partners. Turning to the outfitters business, we are making headway in our efforts to enhance performance and ensure this critical business achieves the results we are confident it can. To be clear, we see great opportunity to profitably grow our share of the market serving businesses and tools and fuel our B2C customer acquisition engine. Our partnership with American Airlines and the upcoming launch of our partnership with Santander are great examples of our work to earn the business of large accounts. In addition, we will launch a new partnership with Healthcare Corporation of America in the first quarter of 2024 outfitting 3,500 managers and frontline employees in their service division. Similarly, we are expanding on the progress we made last quarter in our school uniform business through new relationships with school districts that will ramp up in 2024. We continue to see schools as a key pipeline for our outfitters business and having achieved a 92% satisfactory rate among our existing school partners this season, we believe we are well positioned to capture additional market share. We are providing innovation in our business with a planned introduction of integrated sizing technology for select B2B customers in schools with plans to roll it out more broadly. This tool allows the purchaser to scan their body with their phone and get fitted with a 97% accuracy rate, driving both customer satisfaction and an expected reduction in returns and exchanges. This technology, which takes into consideration personal privacy and information security, also has applications to our B2C business, and we are actively exploring ways to integrate it with the consumer experience. We’re taking steps to drive efficiency across our B2B business during the process of reorganizing and revamping the organizational structure of our division to expand our reach and capture greater market share. We recently hired a new B2B business development leader with over 20 years of experience, who is focused on building out a pipeline of mid-market and enterprise opportunities. We also restructured our portfolio management team from a regional focus to a business segment focus to enable our teams to hyper-focus on the unique needs of each customer growth. We’re working with our partners at Salesforce to enable a stronger data-driven sales process and also implementing marketing automation technology to improve customer communication, create better-defined customer journeys from outreach and lead generation, and more effectively engage with existing and prospective customers. Moving to our third-party business, we saw a nice improvement in the quality of the demand, thanks to the deliberate approach we took to better tailor our assortment to each marketplace and lean into successful categories with a focus on quality of sales, improving gross margin, better inventory turn and freshness. The results were favorable, with Macy’s, Target and Amazon performing consistently well with women’s outerwear and swim driving demand across each of these marketplaces. With the holiday season underway, Lands’ End has launched an exclusive women’s swim collection at Target and select warm-weather doors beginning November 26 for rollout in 200 total doors by early January 2024. The new swim collection includes nearly 70 pieces of our iconic swimwear in new fabric, prints and colors. We’re very excited to be partnering with Target to make our leading product category available to their customers.

Bernie McCracken, CFO

Thank you, Andrew. For the third quarter, total revenue performance came in slightly below our guidance range at $325 million, a decrease of 12.5% compared to last year or 9% when adjusting for our Japan e-commerce business which closed in 2022 and accounted for $10 million of revenue in the third quarter of last year, and excluding the $4 million difference in year-over-year revenue from Delta. As Andrew noted, we delivered adjusted EBITDA of $17 million, up 4% year-over-year, which exceeded the high end of our guidance range. Fundamental to these results is our conscious decision to focus on profitability and balance sheet efficiency versus solely on revenue, which has improved gross profit dollars and margins. Gross margin in the third quarter was 47% and an approximately 700 basis point improvement from the third quarter of 2022. The margin improvement was primarily driven by new products across the brand, strength in transitional outerwear and adjacent product categories, reduction in sales of clearance inventory and improvements in supply chain costs. While we are pleased with our gross margin improvements, we are focused on driving additional supply chain cost savings and product cost reductions and improved seasonal inventory management. While our U.S. e-commerce business saw sales decrease of 10% compared to the third quarter of 2022, we generated an increase in gross profit dollars of 7% driven by our concerted effort to reduce promotions within categories, especially our outerwear solutions, new products across the brand and improved inventory management. Sales in our Euro e-commerce business in the quarter were down 8% year-over-year, reflecting continued macroeconomic challenges but again, increased gross profit dollars by 18%, driven by promotional effectiveness and improved inventory management. Globally, e-commerce sales decreased 13% from last year or 10% when adjusted for Japan. Sales from Lands’ End outfitters were down 8% from the third quarter of 2022. Excluding the $4 million difference in year-over-year revenue from Delta, the outfitters business was down 3%, primarily driven by high single-digit growth in both our national accounts and midsized customers more than offset by school uniform due to timing shifts in back-to-school deliveries last year related to supply chain disruptions from the second quarter to the third quarter. Revenue for our third-party business was down 22% compared to the prior year, primarily driven by weaker performance at Kohl’s, partially offset by strong performance at Macy’s and Target. Our partnership with Macy’s, which launched this year, is performing very well, driven by strong sales in women’s, swim and apparel. SG&A expenses increased $3 million compared to last year as a percentage of sales, SG&A was 42%, which was an increase of 590 basis points compared to 2022. We primarily attribute this to approximately 400 basis points of deleverage from lower revenues and 145 basis points due to higher incentive-based personnel costs, partially offset by lower marketing and continued cost controls. We’re continuing to look for ways to improve SG&A and we’ll be taking action to drive savings as we evolve our digitally native business. During the third quarter, we took a $107 million impairment of goodwill due to the decline of our stock price and the resulting market capitalization, which led to a net loss for the quarter of $112 million or $3.52 per share compared to a net loss of $5 million or $0.14 per share in 2022. Excluding the non-cash goodwill impairment, our adjusted net loss was $4 million or $0.11 per share. Moving to our balance sheet. Inventories at the end of the third quarter were $422 million compared to $565 million a year ago. A 25% improvement in our inventory position was a result of the actions the company has taken to improve inventory efficiency by reducing inventory purchases and capitalizing on speed to market initiatives. Year-to-date net cash provided by operations was $163 million, improving from last year, primarily due to this improved inventory productivity. In terms of our debt, at the end of the third quarter, our term loan balance was $234 million and our $275 million ABL had $110 million of borrowings outstanding, which was $50 million lower than the third quarter last year. Despite lower borrowings outstanding on the ABL, we continue to have elevated interest expense driven by higher market rates. We’re continuing to explore opportunities to refinance our debt and are committed to doing so subject to favorable market conditions. During the third quarter, we repurchased $3 million worth of shares under the company’s previously announced $50 million share repurchase authorization, bringing the balance of the remaining authorization to $32 million as of the end of the quarter. Now moving to guidance. Building on our prior discussion, we are continuing to prioritize high-quality sales and improved cash flows, which we expect to drive continued gross profit and margin expansion during the holiday season. In the fourth quarter, we expect net revenue to be between $490 million and $520 million. We expect adjusted net income of $8 million to $11 million and adjusted diluted earnings per share to be between $0.25 and $0.34. We expect adjusted EBITDA to be in the range of $217.5 million to $231.5 million, which takes into account SG&A impacts related to normalized compensation approach. Based on our third quarter results and fourth quarter guidance, we’re updating our full-year guidance and now expect net revenue of $1.45 billion to $1.48 billion. We expect adjusted net income to be in the range of a net loss of $5 million to $2 million and an adjusted diluted loss per share of $0.16 to $0.07. We expect adjusted EBITDA to be in the range of $80 million to $84 million. Our guidance for the full year incorporates approximately $35 million in capital expenditures. As we have discussed, our improved inventory benefit will enable us to maintain inventory at normalized levels and bolster our work to further expand gross margin moving forward. And with that, I will turn the call back over to Andrew.

Andrew McLean, CEO

Thank you, Bernie. Before we wrap up, I’d like to briefly touch on our holiday sales trends. Like other retailers, we introduced Black Friday promotions earlier this year and began to see traffic ramp up as we progressed through November with significantly stronger traffic and increased gross profit dollars across our channels on Black Friday and over the weekend. This holiday season, we are better engaging with our customers through our improved brand focus leading to higher-quality sales, further supporting our enhanced inventory position as we approach the end of our fiscal year. Like other retailers, holiday promotions are higher than across the balance of the year. However, we continue to scale those promotions back versus prior holiday periods and remain committed to our strategy of driving increased gross margin in both dollars and rate. We will remain competitive with our pricing and be smart about how we target the different segments of our customer base to drive strong demand throughout the holiday season. However, we remain cautious given the additional weekend between Black Friday and Christmas, which could push some business later and beyond our shipping deadlines. As I mentioned earlier, we are confident that we have found the winning formula to achieve more compelling sales by focusing on a better understanding of our customers’ shopping behavior and faster-moving inventory. Our customer-centric strategy is working, as I am pleased with the progress our team has made. As we continue to play to our strengths and improve operational efficiencies across the business, we’re well positioned to finish strong through the year. That concludes our prepared remarks. We look forward to your questions.

Operator, Operator

We will take our first question from Dana Telsey with Telsey Advisory Group. Please go ahead.

Dana Telsey, Analyst

Hi. Good morning everyone and nice to see the progress on the profitability. The continuation of the lower inventories, I think down 30% in the second quarter, down 25% now in the third quarter. Where do you see what the normalized rate of inventory level should be, how are you planning that going forward? And then on – it’s nice to see scaling back on the promotions that you are seeing, especially post the Black Friday time period, what are you seeing in terms of categories, outerwear, how are you planning? How are AURs? And then on the margin focus, what are you seeing in terms of under the hood on the margins, whether it’s freight or whether it’s AUC, what is the opportunity for the gross margin going forward? Thank you.

Andrew McLean, CEO

Dana, how are you?

Dana Telsey, Analyst

Good. How are you?

Andrew McLean, CEO

Good. So, leading into the question that we continue to see opportunity with inventory and pulling that back, working on the business more to return and see an opportunity to move in the business between three turns and four turns. I mean obviously, it gets harder as the turns increase where you are looking, but it’s a function of the speed that we are putting into our supply chain. So, I mean we have talked a lot, and this is going to be related to your AUR comments as well. We have talked a lot about getting speed in and having more freshness, more consistently in the business month-after-month instead of the more traditional model of not buying twice a year. That in itself will give us more opportunity to increase the turns going into next year, and it will give us the opportunity to just show up and maintain the average of retail. I want to talk to scaling back promotions. We scaled back promotions even through Black Friday and Cyber Monday. I just want to emphasize that point in the script. We did start early, one of the things I have noticed about Lands’ End, it’s probably more to do with our capital in history than everything else. We really kick off holiday in October. October tends to be a bigger month for us than August, but that’s different than I have experienced in my career. And it’s really – it’s the start of the holiday shopping period. And holiday for us is really all about successful October and November and that last couple of weeks after Cyber Monday. So, what you saw is that really begins to market Black Friday in October, consistent with our starting holiday, and that’s what’s new in there. In terms of the overall level of promotion, they were falling and they were falling consistently. You would see it going up to 70% like last year, while we started at around 40%. But that’s where we have started as we sort of pulled the needle out in terms of where the problems are at. We saw that the customer came with us on the journey, particularly when we offered newness in there. We noted in the call in Q3, and it’s been something we have seen all year that the women’s categories were all posting double-digit comps and gross margin comps. And it would be fair to say that we have seen that continue. We have seen very successful acceptance of our products in those categories. Regarding your question about categories, as we focused, we took some changes in how we approached outerwear. Coming through last year, we clearly were taking our fabrics outside into broader markets. We were discounting them as gifting for Black Friday or Cyber Monday, and it was just too much discount to be giving. And I felt we needed to take a different direction on that. In addition to that, it’s not a political statement. Winters are getting warmer and they happen later. So, we changed the weighting of the fabrics and the products that we brought in really for the early part of the holiday. So, it was less about that heavy outerwear, I can tell you, certainly in the Midwest today as we sit here in the snow. But for the first five weeks, six weeks, we really got behind other programs. We brought in a pricing structure that’s been very successful. It gave us a price point at a margin that actually fits with the current climate. In addition to that, we brought in a new middleweight jacket. We introduced a new program called wonder weight and when it balanced it, but it’s packable and pulled down, and it’s been a very successful sort of entry price point into heavier outerwear for us. So, we’re very pleased with warehouse performance and how women’s has performed. And actually, we showed that we brought categories alongside that along for the ride. We saw good performance in men’s, and actually even products like Hub last year. I remember this very clearly, we were discounting Hub very heavily. We haven’t needed to do that. And the one-off that we gained was towards a $10 Supima Towel, which we sold a lot of that day. There was about pent-up demand waiting for it. Last part of it, as we think about the AUC and the margin conversation, we have got a lot of our gains in Q3 from actually lower discount rates. The real benefit of the average cost work that we did is still needed to come to us. If you remember, we made the arrangements and changes in our sourcing organization to move to lean funding that was a Q2 event, and we will see the full effect of that in the back half of next year. So, we still think that the best is to come in terms of continued margin upside from AUC. And the discounting, we have started with women’s and like women’s is where we have seen the most progress as we expand that thinking to other categories. We see that we will be able to continue that momentum as well. And it’s the story as best, Dana, we stayed with it pretty consistently since I took over and I am absolutely committed to it. I believe we will get this done. And this is a really great margin story that we have at Lands’ End at the moment and really a re-elevation of our product. And then, Dana, I will just add for the inventories for perspective that you can use pre-pandemic levels as a guide to what our future levels will be and the timing of the inventory levels. And you also have the benefit of our licensing arrangements that we have announced that will also help reduce our inventories.

Dana Telsey, Analyst

Got it. Thank you very much.

Andrew McLean, CEO

Thanks. You bet.

Operator, Operator

Thank you. Our next question will come from Alex Fuhrman with Craig-Hallum Capital Group. Please go ahead.

Alex Fuhrman, Analyst

Hey guys. Thanks very much for taking my question. So, clearly, the focus on prioritizing profitability over revenue is producing some nice results here. I am curious how much more room you think there is to pull back on unprofitable sales? Could there be another leg down of revenue as you identify more promotions or clearance activity that you want to pull back on? And then looking out over the next couple of years, as you add more high-margin revenue, presumably from growing the licensing business, can you continue to grow EBITDA without necessarily a big increase in revenue? Can this be a $100 million EBITDA business on the current $1.5 billion revenue base as you start to grow some of those other areas like licensing?

Bernie McCracken, CFO

Yes. Alex, I am not sure you have been sitting in some of our strategy meetings. But yes, I think what really is important for us when we talk about licensing, that’s one of the strategies that will reduce our current sales. When we get out of the products we are not as focused on and we don’t have authority on, we will be able to drive better profit, a better net income number from a licensing arrangement than selling a lot of product at clearance that we tended to do in the past. So, I think you would definitely hit on that we expect to be able to drive up to $100 million of EBITDA as a $1.5 billion revenue company.

Andrew McLean, CEO

And we can say that, Alex, it’s like as we look further out, there is a point where we reeducate the customer. That’s what’s happening right now. I mean that we have customer deciles and our lowest decile is the one that we have probably averaged the most customers; they love the brand, they are committed to the brand. You know what customers come then they stay with Lands’ End for 17, 18, 19 years. What they are struggling most to respond to is that they traditionally use it a bit like a clearance option, which is that they put product in their basket, wait for the price they want, and then they will buy it. We are moving towards customers who will buy the product or it won’t be there. We are not going to discount our product. We are going to spend on our brands and stand on what we believe are the key attributes of the Lands’ End solution company that we have built and we are going to drive that. And I think what you will see, and we are seeing ourselves in our internal discussions, is we are shifting from a simple decile-based model that looks at our customers the same, and we are moving to a more thoughtful psychographic model that looks at customers in cohorts. The two cohorts that we have identified are resolvers and evolvers. It would be fair to say that we have used the fourth quarter to start repositioning some of the thinking around them and how we go to market to them, how we sell to them more uniquely versus more generically and how we attract them, part of what we have been doing in Q4 and part of what we use Black Friday and Cyber Monday for is to go out and find new customers, new customers that we like, which is why we talk so much about social media. We really like the customer we are finding from that. They fit our revolver platform, and they are much less inclined to buy at a discount. So, we are doing the hard work right now. The commitments you are getting from me, the commitments you are getting from this management team is that we are going to deliver gross margin comps in dollars. This isn’t just about getting rate and declaring victory. We understand, we are here to drive EBITDA and ultimately earnings per share. And it’s like we are fairly focused on that. So, we are constantly evaluating that and threading that needle every day, be it Black Friday, Cyber Monday or just Casual Tuesday in January.

Alex Fuhrman, Analyst

Okay. That’s really helpful. Thank you. I appreciate your insights, and congratulations again on the strong third quarter results.

Andrew McLean, CEO

Thank you.

Operator, Operator

This does conclude today’s Lands’ End third quarter earnings call. You may all disconnect at this time and have a wonderful day.