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Edited Transcript of NWY earnings conference call or presentation 29-Nov-18 9:30pm GMT

Q3 2018 New York & Company Inc Earnings Call

New York Dec 6, 2018 (Thomson StreetEvents) -- Edited Transcript of Rtw Retailwinds Inc earnings conference call or presentation Thursday, November 29, 2018 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregory J. Scott

RTW Retailwinds, Inc. - CEO & Director

* John M. Worthington

RTW Retailwinds, Inc. - Former President & COO

* Sheamus G. Toal

RTW Retailwinds, Inc. - Executive VP, COO & CFO

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Conference Call Participants

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* David Kanen

* David Michael King

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Oliver Chen

Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst

* Allison C. Malkin

ICR, LLC - Senior MD

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Presentation

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Operator [1]

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Greetings, and welcome to RTW's Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Allison Malkin, ICR. Please proceed.

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Allison C. Malkin, ICR, LLC - Senior MD [2]

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Thank you. Good afternoon, everyone. Before we begin, I would like to remind you that some of the comments made on today's call, either as part of our prepared remarks or in response to your questions, may contain forward-looking statements that are made pursuant to the safe harbor provision in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those projected in such forward-looking statements. Such forward-looking statements are subject to risk and uncertainties as described in the company's filings with the SEC, including the company's fiscal year 2017 Form 10-K. As a supplement to today's presentation, we have made slides available, which you can view under the Investor Relations section at www.nyandcompany.com.

And now I would like to turn the call over to Greg Scott, CEO.

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [3]

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Thank you. Good afternoon. Welcome, everyone, to our first call as RTW Retailwinds. In changing our name, we're establishing a strong and distinct corporate identity, which reflects our evolution in one of the largest specialty women's omnichannel and digitally-enabled retailers with a powerful multibrand lifestyle platform poised for growth. RTW reflects our vision to maximize the power of our platform to create destination, celebrity and lifestyle brand assortments across categories and channels. Joining me on today's call are John Worthington, our President and COO; and Sheamus Toal, our Executive Vice President and Chief Financial Officer. I'll begin by reviewing our performance for the third quarter, highlighting the key areas of focus we have in place to sustain and accelerate our momentum throughout the year.

Building off our continued momentum, we continue to see our strategies resonate throughout the business as reflected by our better-than-expected earnings, our highest third quarter operating income in over a decade with positive comp store sales, expansion in gross profit margins to the highest levels since 2006 and expense leverage producing $2.4 million in non-GAAP operating income. These results exceeded our guidance of $1 million to $2 million in non-GAAP operating income as well as the prior year's result of $1.3 million. These results were supported with comp growth of positive $0.2 million and gross profit margin expansion of 80 basis points, reflecting the combined strength of our lifestyle multibrand platform and operating discipline. Finally, we ended the quarter with nearly $84 million in cash on hand, $1.26 per share and no debt.

Turning to our third quarter results. I'd like to spend a few moments discussing our progress against our 2018 keys to success, which contributed to the positive performance in the quarter. First, we continue to leverage our celebrity collaborations and sub-brands as market differentiators that our customers can only find at New York & Company. In August, we announced our multiyear partnership with Kate Hudson as part of our strategic effort to expand our casual lifestyle projection to case individual collections as well as the face of our Soho Jeans sub-brand. Together with our successful Eva Mendes and Gabrielle Union collections, which continued to expand in the quarter. We anticipate growing our celebrity lifestyle brands to 15% share of the New York & Company business. Eva and Gabrielle have both been phenomenal partners to New York & Company, and we look forward to having Kate's influence to further advance our multibrand lifestyle platform.

For the third quarter, our celebrity collaborations and third-party design partnerships continued to expand and more importantly, delivered significant margin increases as we have excluded these assortments from many promotional events, including storewide promotions. Our customers continue to tell us that she is willing to pay a premium for fashion and celebrity collaborations that are exclusive to New York & Company. In addition, I'd like to share a few third quarter highlights regarding our core New York & Company categories and sub-brands. In our largest sub-brand, 7th Avenue, we delivered positive comp supported by comp growth in jackets and pants, with pants a critical component of this sub-brand's success. This sub-brand represents nearly 35% of our business, and is an area of competitive strength for New York & Company and is a strong driver of customer loyalty anchored in pants, driven by introduction of new silhouettes. Our win-a-pant strategy continued to drive customer loyalty and delivered the highest comp growth in this sub-brand. In addition, with Gabrielle Union as 7th Avenue's ambassador, we continue to see the translation of celebrity and the associated halo as elevating this sub-brand's performance.

Seasonal categories, including sweaters and outerwear were off to a strong start in the third quarter, and we are pleased to see the momentum in these areas carry forward into early holiday. Our outlet channel delivered positive comp results, which benefited from the strategic shift to a shared assortment. By leveraging our known best-selling styles, we have enhanced the profitability of our outlet channel and continued to realize strong margins gains during the quarter. Our performance within our casual sub-brands, Soho Jeans and Soho Street was softer than anticipated in the quarter. We are confident that our multiyear partnership with Kate Hudson as our Soho Jeans' celebrity ambassador, will allow us to further amplify our casual life style projection, which represents approximately 25% of our volume.

Number two, the positive halo celebrity partnerships and sub-brands also support our second strategic priority to increase brand awareness and customer engagement. We continue to leverage our celebrity partnerships in order to build awareness. Our PR impressions for the quarter increased 32% over the prior year. Celebrities are a critical driver of brand awareness and affinity, and we are pleased to see this strategy elevate the New York & Company brand. The power of our celebrity social presence provides an additional vehicle driving interest and visits as we now have the opportunity to reach a combined nearly 30 million followers across Eva, Gabrielle and Kate social channels.

Number three, our third strategic priority focused on driving digital and omni. For Q3 2018, we continue to grow our e-commerce channel as a leader within the specialty women's apparel industry, increasing to over 31% of volume as compared to nearly 29% last year. The growth in our digital business is driven by the increase across all key metrics, which reflects increased awareness and power of the New York & Company brand and our celebrity collaboration. In addition, our exclusive merchandise, which allows us to expand our fashion projection through new styles and categories, delivered double-digit comp performance in the quarter. Our exclusive assortments were also size-inclusive as we offered sizes 00 to 20 in nearly all styles, including our celebrity collection.

Next, I would like to discuss our operational priorities and highlight the progress we are making against being a leaner, faster, more efficient and more responsive organization. Regarding our real estate portfolio, we experienced continued leverage of our store expenses with store closures and an ongoing landlord rent concessions contributing to the decrease in buying and occupancy cost. We also benefit from a highly flexible real estate portfolio with nearly 70% of our existing store base on 2-year lease terms. During the quarter, we opened 4 new locations, including returning to State Street in Chicago and expanded our Fashion to Figure fleet with 2 new stores. John will elaborate further on the steps we are taking to rationalize and optimize our store fleet.

Next, Project Excellence. We remain committed to looking at every cost to improve efficiencies and deliver a more profitable operating model and are seeing the benefits to the business as a result of several initiatives. First, organization. As we'd discussed previously, we have streamlined the organization. Last fall, we consolidated our New York & Company and Outlet organizations to improve sales and profit while driving efficiencies across channels. In February, we further streamlined our corporate office support functions to combined impact of the Outlet integration, and corporate office rationalization will reduce annualized payroll-related cost by approximately $7 million in 2018. Regarding our Outlet integration, we are seeing the benefit of a combined organization flow due to this channel's performance. We now have a shared assortment between channels and are achieving improved sell-throughs and margins as a result of this coordination among our merchandising, planning, allocation and stores' organization. The improved result across assortment performance, increased IMUs, and margins should continue to benefit our top line and comp and bottom line profitability throughout the year.

Next, pricing and promotions. As I've shared previously, we are focused on driving higher sales and margin through leveraging data analytics and insight, while reducing underproductive promotions. For Q3, we reduced our promotional impressions by eliminating several highly promotional storewide 50 off node exclusion events. We reinvented our banner City Cash promotion, we eliminated multiple in-store coupon events and we eliminated margin-eroding triple points events. We expect continued benefits from this initiative throughout 2018.

Our final strategic priority focused on growth initiatives. We expanded our multibrand portfolio with a relaunch of Fashion to Figure. This acquisition enabled us to enter the $21 billion-plus market and drive accretive growth to New York & Company portfolio. We announced award-winning actress and singer Danielle Brooks as the brand celebrity ambassador for the fall season. In addition, we opened 3 locations during the quarter, including entering the Chicago market, which represents a new market and opportunity to expand the brand's awareness. While we are in the process of developing our long-term strategic plan for Fashion to Figure, we are excited by the potential of this brand. As shared during our Investor Day in September, we are also making investments in future businesses to launch in fiscal 2019. We're expanding our celebrity brand with the launch of our Kate Hudson collection, which will launch as an independent direct commerce brand sold on its namesake site as well as New York & Company stores and .com. We are also entering the lingerie lifestyle market with a brand headed by industry leaders and will also launch as an independent, direct commerce brand, sold on its own site as well as New York & company stores and.com. In addition, I've shared previously that we've launched our subscription box service NY&C Closet available at NYandcompanycloset.com. I am pleased to share that we have built a profitable operating model and continue to grow the subscriber base through a combination of new customer acquisition and expanded share of wallet for existing customers. As we look forward to Q4, while our early November reads were softer than planned, we are pleased to see our business rebound during Black Friday week, delivering a record-breaking Cyber Monday and positive comp improvement for the back half of the month. Importantly, we've made several strategic shifts during Black Friday weekend, which balanced fashion, new deliveries and highly elastic doorbusters that yielded improvement to trend, which reflected in our comp guidance during this highly competitive holiday quarter. In closing, we are pleased to welcome Kate Hudson to further amplify our brand presence and emotional connection with customers. Our celebrity partners Eva, Gabrielle and Kate, our family of sub-brands that can be found nowhere else and the growth of our new businesses FTF and lingerie, are critical to unlocking the potential of RTW's differentiated market position.

With that, I'll turn the call over to John.

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John M. Worthington, RTW Retailwinds, Inc. - Former President & COO [4]

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Thanks, Greg. I'm excited to speak to you on our first call as RTW. As Greg shared, the name change reflects the evolution of our company from a brick-and-mortar retailer selling New York & Company apparel and accessories to a corporate platform for the development of digitally dominant brands. With that, let me share our progress in Q3. We are pleased to report another quarter of improved performance with growth across key operating metrics, including positive comp store sales, gross margin expansion and an increase in gross profit dollars as well as a reduction in SG&A dollars. Combined, we recorded a $1.1 million increase in adjusted operating income to $2.4 million, up from $1.3 million in the third quarter of last year. Financially, the third quarter marked the fifth-consecutive quarter of positive comp store sales, the 10th-consecutive quarter of gross margin expansion and the sixth-consecutive quarter of increased adjusted operating income. On a 9-month basis, the quarter marked an even more significant milestone, our highest operating profit in a decade. We saw a continued strength in outlets with increases in traffic, AEF and AUR. Importantly, we not only saw an increase in sales, but also saw improvements in gross margin and operating income. At New York & Company stores, we saw an increase in conversion, AUR, UPT and ADS. From a regional sales performance, we saw our strongest Q3 New York & Company comps come out of the Southeast and West.

Our Q3 outlet comp performance was strong across the entire country with the best performance coming out of the Midwest, South Central and the West. In the quarter, we continued to benefit from reductions in rent and occupancy and from lower sourcing cost driven by successful negotiations by our teams. In Q3, we experienced our PLCC penetration grow to 45.5% of total sales. For the third quarter, in total, we delivered comp of 0.2 as well as an 80 basis point increase in gross margin, which combined led to an adjusted diluted earnings per share of $0.04, double last year.

Turning now to an update on our key initiatives. I'll begin with our credit loyalty program RUNWAYREWARDS then turn to our real estate strategies, including rent improvement, lease terms, conversion stores and opening new takeover stores. In addition, I'll update you on our omnichannel, e-commerce and close with Project Excellence. As I've mentioned before, this continues to be a strong contributor to our top and bottom line performance. Starting with our RUNWAYREWARDS credit card. We continue to see a strong response to this program, which drives long-term loyalty and comp sales. Last quarter, we went up against the reissue of our PLCC program. Even with this significant launch in the second quarter of last year, our Q3 PLCC sales penetration increased year-over-year. As we said before, our goal is to increase PLCC penetration to approximately 50%. We'll do this by continuing to acquire new customers, grow the spend of our current customer base and focus our efforts to send targeted e-mails to existing customers to drive response.

Now let me turn to real estate. Throughout the first 9 months of the year, we opened 3 New York & Company stores, 1 outlet store and 10 Fashion to Figure stores. We also converted 3 existing New York & Company stores to outlet stores ending the quarter with 428 stores, including 119 outlet locations. We'll continue to selectively open takeover locations in highly productive malls when we can get -- when we can quickly take over a current location that is move-in ready on favorable lease terms. These stores are producing solid sales and store contributions.

Turning now to outlet. As I mentioned, outlet performance was strong across the entire country. The outlet conversion stores also contributed strong performance in Q3, with sales far outpacing our expectations. As we mentioned previously, we started to include some New York & Company clearance into our outlet conversion stores at the start of the year. This has enabled us to continue driving strong traffic and profit at these outlet locations. Importantly, we continue to see a balance basket among customers in these outlet stores, with both clearance and outlet-only product. Our core outlet stores continue to benefit from the New York & Company and outlet integration we rolled out last year as part of Project Excellence. We continue to be focused on optimizing our entire retail fleet ensuring that we have flexible lease terms and are benefiting from the recent rent concessions. Throughout the first 9 months of the year, we closed 18 locations and plan to close an additional 14 to 16 in Q4. As I mentioned, we ended the third quarter with 428 stores, including 119 outlet locations with 2.1 million selling square feet in operation. Importantly, our store portfolio remains very flexible and nearly 70% of our locations are on 2-year or less leases.

Combined, our real estate strategies of outlet conversion, takeover stores and fleet optimization in New York & Company and Fashion to Figure position us well for the fourth quarter and beyond. Our next focus is on our omnichannel strategy. We continue to leverage the investments that we have made to elevate our capabilities and make our business more efficient. As I mentioned, we continue to see improved efficiency in our store productivity. Our associates have become even more efficient with our mobile handheld scanners and tablets, and customers also appreciate the additional flexibility that we've given them through our omnichannel fulfillment options. We expect to continue to leverage these omni features to drive further increases in our omnichannel business as well as efficiencies and productivity in our stores.

Now let me turn to e-com. Our e-commerce business continues to see growth. In Q3, e-com represented over 30% of our overall New York & Company Q3 total sales, up from last year. This important channel serves as a platform to grow our customer file throughout the entire country. We are focused on continuing to aggressively expand this important channel as we go forward.

Finally, turning to Project Excellence, which is now in its fourth year. Since inception, we've realized over $50 million in savings on an annual basis from this initiative and continue to see improvement. This past year, we have focused efficiencies on integrating our New York & Company and Outlet stores organization with solid results. These results are being driven as our New York & Company and Outlet teams operate as 1 organization. We are creating efficiencies across product, visual, merchandising, allocation and our field operations. In addition, we have enhanced our outlet offering with proven assortments and strong sub-brands that resonate with our customers and leverage learning from both channels. Importantly, this integration has enabled us to lower cost across the business as we leverage our sourcing capabilities in both channels.

In terms of our sourcing strategy, we continue to work to build strong partnerships with our key agents and factories, which we expect will help us to further improve speed to market and reduce cost. We have recently returned from our Asia sourcing trip where we held very productive meetings and conversations with our suppliers. We are now realizing approximately $10 million in benefits annually from these sourcing strategies, and expect continued benefits from our recent actions. Overall, we're pleased with the results that we are seeing from Project Excellence in real estate, private-label credit card, sourcing, omni and our overall organizational structure. We are positioned to continue to drive our efforts to reduce expenses, improve efficiencies and productivity and, of course, drive profit to the bottom line.

In closing, again, we are very pleased with the continued positive momentum in sales and operating performance this year. We are excited to further the progress that we have made to drive sales and profitability in our ongoing efforts to increase value for all RTW shareholders.

With that, I'd like to turn the call over to Sheamus to review our third quarter results as well as our outlook in greater detail.

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [5]

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Thank you, John. Good afternoon, everyone. Net sales for the quarter were $210.8 million as compared to $214.2 million in the prior year. The decrease in net sales reflects a reduction of 31 stores, partially offset by growth in eCommerce sales and increased sales from Fashion to Figure. Comparable store sales increased 0.2% as compared to the same period last year, representing the fifth-consecutive quarter of positive comparable store sales, which was led by growth in the company's eCommerce business and strength in outlet stores, and in particular outlet conversion stores. In the comparable store sales base, average dollar sale per transaction increased by 3.7%, while the number of transactions per average store decreased by 3.4%.

Gross profit as a percentage of net sales increased 80 basis points to 32.4% versus the prior year third quarter gross profit percentage of 31.6%, reflecting the highest gross profit margin achieved in the third quarter since 2006. The increase during the quarter reflects 140 basis point increase in the leverage of buying an occupancy costs, partially offset by a 60 basis points decrease in merchandise margin, reflecting a slight increase in promotional activity and increased shipping costs.

Selling, general and administrative expenses were below our prior guidance at $66.8 million or 31.7% of net sales as compared to $67 million or 31.3% of net sales in the prior year period. The current year's SG&A expenses included $0.8 million of nonoperating charges, relating to consulting and legal expenses, combined with costs associated with the company's registration statement. The prior year also included $0.8 million of nonoperating charges, primarily resulting from severance related to the integration of our brick-and-mortar channels. On a non-GAAP basis, selling, general and administrative expenses were $66 million or 31.3% of net sales as compared to non-GAAP selling, general and administrative expenses of $66.1 million or 30.9% of net sales in the prior year. GAAP operating income was $1.6 million as compared to $0.6 million in the prior year period. The current year third quarter included nonoperating expenses of $0.8 million as compared to the prior year period, which included net nonoperating expenses of $0.6 million. Excluding these nonoperating adjustments, non-GAAP operating income was $2.4 million, which exceeded our guidance of $1 million to $2 million, and exceeded the prior year's non-GAAP operating income of $1.3 million.

GAAP net income for the third quarter of fiscal year 2018 was $1.7 million or $0.03 per diluted share as compared to $0.4 million or $0.01 per diluted share in the prior year period. Excluding the nonoperating amounts, non-GAAP net income was $2.5 million or $0.04 per diluted share, increasing from $1 million or $0.02 per diluted share in the prior year period.

Total quarter-end inventory decreased 3.2% reflecting reduced inventory due to lower store count, partially offset by an increase due to the inclusion of the Fashion to Figure business. Capital spending for the third quarter of 2018 was $2.1 million as compared to $3.1 million in the prior year period. We ended the quarter with approximately $84 million of cash on hand and no outstanding borrowings under our revolving credit facility and no long-term debt.

Regarding expectations for the fiscal year 2018, we continue to focus on improving operating results to drive increases in both operating income and EBITDA. As previously disclosed, fiscal year 2017 included an extra week in the traditional retail calendar, which resulted in $12 million in sales and contributed positively to our operating results in the prior year.

As such, the fall season in 2018 and more specifically the fourth quarter, includes 1 less week of sales than the prior year period. As we enter the fall season, the combined effects of this 1 less week, in addition to shifts in the calendar from the 53-week year in 2017, and new revenue recognition standards, will have an impact on the overall seasonal results and the fourth quarter results. And as such, we will provide commentary on the overall fall season, which combines the third and fourth quarters of fiscal year 2018, and more detailed commentary on the fourth quarter metrics. For the fall season, combined third and fourth quarters of fiscal year 2018, we expect GAAP operating income to be in the range of $2.5 million to $4.5 million, which includes $3 million of nonoperating adjustments, including $1 million of non-GAAP charges and $2 million of new business start-up costs as compared to the prior year GAAP operating income of $5.6 million, which included the benefit of 1 additional week of sales and margin due to the 53-week year in 2017. For the fourth quarter, we are expecting GAAP operating income of $1 million to $3 million as compared to GAAP operating income of $5 million in the prior year period.

The fourth quarter guidance reflects the following: net sales are expected to decrease in the mid- to high single-digit percentage range, reflecting the combined effect of 1 less week of sales due to the exclusion of the 53rd week and a reduced store count, partially offset by the inclusion of Fashion to Figure. Comparable store sales, which are shifted to compare a light calendar week, are expected to be approximately flat. Gross margin is expected to be approximately flat, reflecting decreased product cost and reduced promotional activity, offset by increased shipping costs related to the eCommerce business.

Selling, general and administrative expenses are expected to decrease by $3 million to $4 million versus the prior year's fourth quarter. This reflects the elimination of the 53rd week, reductions in variable compensation and reduced payroll, partially offset by increases in selling expenses driven by increases in eCommerce variable costs. On a rate basis, selling, general and administrative expenses are expected to deleverage due to the elimination of the sales from the 53rd week. Total inventory at the end of the fourth quarter is expected to decrease in the low single-digit percentage range as compared to the prior year reflecting decreased inventory on hand, partially offset by an increase in in-transit inventory. Capital expenditures for the fourth quarter of 2018 are projected to be approximately $4.5 million to $5.5 million as compared to $4.7 million of capital expenditures in the fourth quarter of last year, reflecting our continued investments in our information technology and omnichannel infrastructure and real estate remodel, refresh activity. Capital expenditures for the full fiscal year are expected to be in the range of $8 million to $9 million as compared to $12.5 million last year. Depreciation expense for the fourth quarter is estimated at $5.5 million.

With that, I would like to turn the call over to the operator to begin the question-and-answer portion of the call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Oliver Chen with Cowen and Company.

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Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [2]

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It sounded like you were quite agile and creative about the promotional environment in terms of what you saw during Black Friday and Cyber Monday. If you could help us understand how that paced relative to your expectations. Also the gross margin was very impressive, do you expect to continue to see that buying and occupancy benefit, and also what are your thoughts ahead for the next margin?

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [3]

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So I'll talk about Black Friday week and Cyber Monday. I would say as we said on our prepared remarks, early November started softer than planned. And what we saw for Black Friday is we really believe it's kind of a Black Friday week that starts on Sunday of that week and moves all the way to Cyber Monday the following week. We saw some really strong performance early in the week of Black Friday week, which culminated in really a very strong Cyber Monday for us, which was our strongest Cyber Monday in our history. So we were pleased with that. We definitely were super agile in changing promotions, messaging throughout Sunday and Monday of the week and that really drove strong traffic and conversion in sales on Cyber Monday for us, which really helped us for the Black Friday period. Sheamus, do you want to talk about...

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [4]

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Yes, in terms of overall margin, as you noted, we have seen some significant increases over the last several quarters and last several years. We continue to expect to see margin improvements over the longer term. So our expectation over the next few years, we should see our overall margins move into the mid-30s from the low 30s where they are today. That will come through a combination. I know you referenced the leverage of our occupancy cost. We continue to be very aggressive in terms of looking at occupancy cost for opportunities to reduce that and better leverage those expenses. So that'll certainly be a component of the improvement over time. But we are also anticipating some level of improvement in our overall product or merchandise margins due to a combination of our continued work in terms of sourcing activities as well as the enhancements that we're making to some of the promotional activities, as Greg talked about and that we have talked about in the past with some of our recent efforts with L.E.K study and some of those initiatives that we've implemented. So I think on an overall basis, we would expect to see continued margin improvement as we progress over the next few years. I think we guided for Q4 for it to be relatively flat, but as we move beyond Q4 we are anticipating to see further enhancements in margin.

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Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [5]

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And what are your latest thoughts regarding tariffs? You've done a really good job of thinking about your supply chain and also making changes to speed and development. Would love how you see that evolving? And the Kate Hudson announcement continues to be very exciting. Would love your thoughts on who that customer is and how that customer will fit into your matrix to drive difference?

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [6]

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Yes. So a couple of things. Regarding tariffs, obviously, the first tariff that went into effect probably late September, early October, affected a very small percentage of our inventory mainly some handbag, knitted hats and PU jackets or full-leather jackets. We're continuing to have a keen eye on that and what will happen in January, whether those categories will also continue -- will increase in their tariff. One of the things that's super important to us is as always, is country migration as about 50% of our product in ready-to-wear is made in China. We're continuing to look at new countries to produce, specifically in sweaters in Bangladesh, and in denim in Bangladesh, really to -- really offset, which could be -- which could possibly be tariffs in apparel though that has not been stated nor is there announcement around that. But we're staying very close to it. I think country migration and the flexibility through our sourcing partners is key. One of the things, for instance, we're doing in Chinese New Year, we're using one of our domestic suppliers who make prints and cuts fabric here and makes in El Salvador to really use that as a place where we're going to do a lot of our chases during the Chinese New Year holiday. So we're continuing to look for new places to manufacture and country migration out of China has been a long-term strategy, but it's probably becoming to have a little more intensity now with tariffs and really the uncertainty of what's going to happen. Secondly, I think with Kate Hudson, I think we're incredibly excited about that collection. We'll be announcing the name probably in early January. Its collection I think is incredibly chic, it is very Kate Hudson in feel. What's exciting about this is, we are going to first time have it on its own namesake site as well as sell on our New York & Company marketplace as well and select New York & Company stores. We also really hope 1 day that this also can sell in other venues and other retailers as well as we're really developing this collection not to be sold exclusively at New York & Company. I think from a consumer basis as Eva Mendes and Gabrielle Union, we seek to find consumers who will be -- can join the New York & Company brand, and we think Kate Hudson with her 9 million-plus Instagram social followers, we have a really strong way to announce that this collection is sold at New York & Company and her namesake site to introduce those customers to our brand. What I think we find with Gabrielle Union and Eva Mendes, what they do is they bring new customers to the brand and we believe Kate Hudson will as well.

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John M. Worthington, RTW Retailwinds, Inc. - Former President & COO [7]

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The only other thing, Oliver, on tariffs that I would mention, we've gone from 65% of our product coming out of China down to 50%. Greg had mentioned the 2 largest categories, sweater and denim are primarily coming out of there, but we are experiencing some nice quality and some efficiencies out of Bangladesh and some of the other neighboring countries. So we'll continue to look at that. The one thing we don't want to do is compromise quality, efficiency or speed. And clearly, when you are going into some of these countries who are not as efficient in some of these categories you want to make sure that we're up to speed and we don't compromise anything. But we are very focused in the guide, going from 65% to 50%, and hopefully we'll go south of that very soon.

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Operator [8]

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Our next question comes from the line of Dave King with Roth Capital.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [9]

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Maybe following up on the margin line of questioning a bit, it continued to improve both the growth and the operating level. Looks like you took down the Q4 implied guide a little bit for the non-GAAP operating income, I guess, what drove that? Was that increased start-up cost for some of these new initiatives? And then what sort of impact does the 1 last week have on operating income or EPS if you have that?

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [10]

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Yes, so -- Dave, so in terms of -- couple of things there. In terms of the overall margin impact, I think as I said, we are anticipating continued margin improvements as we look for the quarter. I would say the overall margin rate is approximately where we originally envisioned. So I don't think there's been a significant change in our implied guidance in terms of the overall margin rate. I think as Greg commented earlier, in terms of the quarter, we have taken down the expectation slightly based upon the trend very early in the quarter. So I think from an overall sales standpoint that has been a slight revision for us based upon the early part of the quarter. As Greg mentioned, we are very pleased to see that during the Black Friday week, we were pretty comparable to our results from last year, and really had a dynamic Cyber Monday, exceeding our expectations and exceeding our historical results. So a couple of things tweak there, in terms of the early performance, and then I think we're cautious with respect to the rest of the quarter, given the highly promotional retail environment that we anticipate during this kind of challenging promotional season. So that's all built into our existing comp results.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [11]

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It sounds like more sales are -- go ahead. Go ahead.

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [12]

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Yes. So I think we're -- it's still early in the quarter, early in the holiday season. There's a lot of big weeks still ahead of us, and we're cautiously optimistic that we'll see this trend continue and improve as we go through the quarter.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [13]

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Okay, great. So it sounds like it's more sales driven than anything else. Did -- but to be clear, did you take up the amount of start-up cost that you're expecting now with the lingerie or more for Kate Hudson? Were there any changes there in terms of amount of cost to start-up those...

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [14]

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We have not. So that really has not changed. If you look back at our -- some of our commentary previously, I think we've always envisioned that the start-up costs were going to be approximately $2 million. I guess another thing that I would say about that is as we look at those new businesses while there is certainly some modest start-up cost initially here before we launch, we've taken a very risk-aversed approach to this. So these businesses are really plug-and-play strategies into our existing infrastructure, into our existing capabilities. So they are not as if we're investing a high amount of capital to launch these businesses. So I think we're seeing some of the operating expenses before they operate and generate sales, but this is a pretty risk-averse way to enter these businesses. So we feel comfortable about that. The last thing, I know you touched on was the 53rd week. As we've commented, it is a sales difference for us in terms of top line sales, that was about $12 million of top line sales for us last year. It was a profitable week for us. As we look at the -- that period, it gets a little subjective at how you allocate certain cost. But as we look at it, it was about a $12 million sales week for us, and depending upon how you look at some of the cost anywhere from $1 million to $2 million profit week for us. So it did help us last year. And as we anniversary that, we just wanted to call that out.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [15]

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Perfect, okay. And then switching gears, Greg, what can you share about the customer response so far to Kate as the spokesperson for Soho Jeans. I think you said it was softer a little bit than expected in the quarter. I guess, do you still expect it to have the same magnitude of relative benefit that Gabrielle had for 7th Avenue, it sounds like you do, I just -- curious as to why or why not, and maybe why out of the gates it wasn't necessarily as strong?

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [16]

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So I would say with Kate Hudson, we are continuing to be incredibly excited about this partnership. In February of Q1 of 2019, we will really relaunch Kate as the face of Soho Jeans. And when I say relaunch, I think I would say that we definitely had a softer launch with Kate in the fall season. One, yes, she was in our windows. We did not do a lot of external marketing through it. One of the reason is Kate had some other things going on. And so basically, we really were a little softer in that launch, and then even in Q4 we really did not do a new marketing campaign with her. That said, we're incredibly excited about what can happen in spring, both with the launch of her as -- really the relaunch of her as the face of Soho Jeans and also with the launch of our own collection in March. I will say we did see even with the softer launch that we saw Kate Hudson bringing new customers to the brand in fall, which is really what we like to see, which we saw from Gabrielle and Eva.

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Operator [17]

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(Operator Instructions) Our next question comes from the line of Dave Kanen with Kanen Wealth Management.

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David Kanen, [18]

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Sheamus, if you could explain to me on an apples-to-apples basis the guidance year-over-year, with the start-up cost. If you could just reiterate that so I can understand it a little bit better?

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [19]

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Yes, sure. So in terms of the fall season, as we commented, we're guiding to $2.5 million to $4.5 million of operating income. That operating income includes $3 million of expenses. Some of which are what we would characterize as non-GAAP charges, approximately $1 million, and there's about $2 million of start-up cost associated with the new businesses. So the guidance range of $2.5 million to $4.5 million for fall includes those expenses within those expectations. As we compare that to last year, our last year results, as I said, included approximately $12 million of sales related to the 53rd week. So that was built into the sales results for last year. And as I commented on the call, that was a profitable week for us, so it did help us from an operating profit perspective as well.

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David Kanen, [20]

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So last year, what was our operating profit last year? And then if I add back the $3 million of $1 million charge, the $2 million of start-up, apples-to-apples, what's the comparison. And when you say fall, you're talking about -- you're combining Q3 and Q4, is that correct?

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [21]

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Yes. Because as you know, there were some shifts in the retail calendar this year and some effect of the new accounting pronouncement that shifted expenses across quarters. So we've been looking at and guiding to a seasonal number because -- to kind of offset some of that noise. So as we -- go ahead, sorry.

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David Kanen, [22]

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So last year's Q3, Q4 operating income was what? And then if I add back...

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [23]

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Yes, so it was about $5.6 million. So within that was the extra week. So if you subtract out the benefits associated with the extra week and then compare it to the numbers that we just talked about, you can get kind of an apples-to-apples comparison.

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David Kanen, [24]

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Okay. So at the midpoint, if I add back the $3 million, you are looking for a slight increase in fall year-over-year, if I add back the $3 million. Correct?

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [25]

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Correct. So if you add back the $3 million, we would be at a range of $5.5 million to $7.5 million versus last year's $5.6 million. But bear in mind that last year's $5.6 million, included $1 million or more of benefit from the 53rd week. So it's really a range of, on an adjusted basis, $5.5 million to $7.5 million versus something less than $4.5 million.

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David Kanen, [26]

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Okay. And then you didn't say this, but we were -- we've been tracking Kate Hudson and she had a baby, which explains her being quiet, if she is listening, of course, congratulations on the baby and you have to do what's best for your family, there's no gripe on this end. But when do we expect her to really be engaged and start posting on social media and so forth and ramping up the awareness and interest?

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [27]

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Thanks. So February of 2019, we will -- or probably the last week of January, we're really going to come out with a real big relaunch of her as the face of Soho Jeans. You will see definitely high engagement there, both from us and Kate. And excitingly around March week 3, March week 4, we will launch her namesake collection and she will be incredibly engaged, we will also have its own social profile as well. So we're excited about both of those and you really will see that really at the early start of 2019.

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David Kanen, [28]

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Okay, well good luck with that.

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [29]

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Thank you.

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David Kanen, [30]

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And then a follow up on the commentary for the improved gross margins going forward. If you could drill down a little bit and give me some detail on the improved expectation for margins going forward. How much would you say is driven by occupancy? How much vendor credits? How much is just being taking less price? If you had to ascribe a percentage to each.

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Sheamus G. Toal, RTW Retailwinds, Inc. - Executive VP, COO & CFO [31]

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Yes. So as we look at it, today we're roughly low 30s in terms of gross margin, 32% let's call it. As we go forward we're anticipating that to move into the mid-30s. So we have certainly 3 or 4 points of margin growth over the next couple of years. I think -- as we've talked previously about the details of that and kind of you're highlighting, it will come from a combination of a few different things. So first is, we are anticipating with some of our new businesses to grow top line sales, which will help us leverage even more some of the fixed components of our margin structure. So as you look at our existing cost of sales today, approximately 1/3 of what we categorize as cost of sales is somewhat fixed in nature and not related to the actual variable cost of our product. So as we can drive topline sales, we will get significant flow through of benefit associated with those top line sales. So the new business initiative, the introduction of Kate Hudson next year becomes a component of that. I think as Greg hinted to earlier, we're looking at different options in terms of sourcing capabilities, country migration, both in an effort to mitigate risk that we see in terms of tariffs, but also look for cost advantages in terms of how we're costing goods and how we're sourcing goods, so there'll be a piece that comes from that. And then further efficiencies in terms of promotional activity due to the implementation of some of our continued learnings from our previous studies in price elasticity will be a third benefit. And then finally, the fourth benefit for us is we continue to be very aggressive in terms of negotiating rent concessions, further rent reductions, looking for -- to capitalize on opportunities, to take over new stores in a cost-effective way that are better than the leverage points that we see in our existing business. So it's really a combination of all 4 of those strategies. And they're all significant pieces of it. So I hope that gives a little color to the components.

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David Kanen, [32]

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Yes, yes. Just in closing, there's something I'd like to add is I usually guess what you're ending cash balance will be, Q4 is usually very -- free cash flow generative quarter, so I'm guessing you'll be somewhere around $105 million. And for the year, will probably be close to $25 million in free cash flow, certainly between $20 million to $25 million. So that being said, as an investor, just a message for management and the board. As an investor, this is highly attractive to me because you're generating almost 20% free cash flow yield, and then we've got the optionality of Kate, which we didn't -- we haven't even seen the benefit of that yet and we're still growing EBITDA and then Danielle Brooks and Fashion to Figure, in my opinion, the lingerie is really outside of our core competency and it seems like a long shot and a Hail Mary, and I sincerely hope that you guys will very seriously manage the risk and if you realize it's more difficult than you thought you'll immediately have the humility to shut it down and not be like a religious zealot and say no, we made our bed, we got to sleep in it and throw good money after bad, but all of the aforementioned, in mind, as backdrop, a strong free cash flow generation, the $100-plus million of cash, the growth initiatives, we should be -- to create value for our shareholders, we should be buying back stock right now. Okay, you have a tremendous opportunity to buy back stock at like 3.5x EBITDA, 20% free cash flow yield. That's something that you could do for shareholders rather than focusing on things like, in my opinion, Hail Marys, like lingerie. So just a message and I hope that you guys will keep a tight rein on things.

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [33]

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Thanks, Dave. I think it's -- I appreciate it. I just wanted to comment on just one thing, really about lingerie. So we will be very mindful of expenses and we will be very mindful of cost, and we will be as prudent I think as we've been and demonstrated with the New York & Company business. We truly believe that Kate, Fashion to Figure and really incrementally lingerie could be growth vehicles for this company, which is what we really are trying to do for all of our shareholders. And I would say that we've done a lot of research around the lingerie space, both in terms of our customer and external customers. We've done focus groups, and what we've seen is our customer doesn't have a perfect place for lingerie. The second thing I would say there is, as you know, we have hired a very strong talent to run the lingerie businesses, been in the business for 25 years, same with the designer there, we also, as you know, have at least 2 for sure highly -- people that are very engaged in the lingerie business, both Grace Nichols and Lori Greeley on our board, who know this space very well. That said, based on all the customer data, the experience -- the expertise we have on our board and the team we hired, we believe it is an opportunity. That said, I understand and appreciate what you're saying. And I just want to give you the confidence and all the shareholders that we are going to be very mindful of cost, and we are going to test it prudently and go into it prudently. And really spend the money on growth vehicles for the company, because all -- we all want to do is grow shareholder value for all of us.

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David Kanen, [34]

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I believe you when you say that, and we'll try and keep an open mind here and if it doesn't turn out the way your research is indicating, I hope you immediately shut it down and focus on what I would consider to be the high-probability opportunities, buying back stock, Fashion to Figure, and of course Kate is very exciting. And I'm looking forward to that in 2019. So good luck, guys.

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Operator [35]

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Ladies and gentlemen, we have reached the end of our question-and-answer session. And I would like to turn the call back over to Greg Scott, CEO, for closing remarks.

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Gregory J. Scott, RTW Retailwinds, Inc. - CEO & Director [36]

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Thank you for joining us today. We look forward to speaking with you when we report our fourth quarter results in March. I would like to wish everyone a great holiday and new year, and I look forward to being in over 40 of our stores during the upcoming holiday. I hope to see you there. Have a great holiday.

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Operator [37]

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