Q3 2023 Lands End Inc Earnings Call
Participants
Bernie McCracken; CFO; Lands' End, Inc.
Andrew McLean; CEO; Lands' End, Inc.
Dana Telsey; Analyst; Telsey Advisory Group LLC
Alex Fuhrman; Analyst; Craig-Hallum Capital Group LLC
Presentation
Operator
Good day, everyone, and welcome to the Lands' End Third Quarter Earnings Conference Call. (Operator Instructions) 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
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 at our website plans and.com. I'm Bernie McCracken, Lands' End Chief Financial Officer, and I'm 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're about to discuss includes forward-looking statements. Such statements involve risks and uncertainties. The company's actual results could differ materially from those discussed on this call. Factors that could contribute to such differences include, but are not limited to those items noted and included in the company's SEC filings, including our annual report on Form 10-K and quarterly reports on Form 10-Q for forward-looking information 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 metrics. 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 and 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
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 December. After having served as our interim CFO since January, I couldn't be more pleased to continue working with Bernie and I'm more than confident that he will continue to lead our financial organization with accidents.
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 build on our momentum from Q2 further improved our inventory position, injecting newness across our assortment and continue to prioritize gross margin improvements to drive incremental gross profit dollars. Our deliberate strategy to improve the relevance of our solution driven products generated more profitable sales, resulting in gross margin and profit expansion and adjusted EBITDA for $17 million above the high end of our guidance range. As I've previously noted, we're executing better 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 improved cash flows as we've now worked to further improve our inventory position is clear. This strategy is working. Q3 marked our third successive quarter of significant inventory and margin improvement at 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 a lower, more efficient inventory geared to our targeted customer cohorts. We're taking advantage of the flexibility that our lower inventory levels provide to continuously refresh our assortment with new styles, colors and fabrics more frequently throughout the year our customers are responding exceptionally well to this approach. As we introduced last quarter, the transition from a demographic focus to behavioral will focus when it comes to our customers. We are zeroing in on two key high-value customer cohort, which we call our revolvers and our progress and leveraging our proprietary data to better understand their shopping behaviors patterns not resolve as are the largest cobalt, other existing base solutions oriented addresses that prefer a classic styles and value quality over trends and shop primarily on necessity two to three times a year. It builds on our second largest cohort and an opportunity for growth and discovering and refining this final, I think, ongoing journey where we will face the current moment. They generally have more volume potential and spent more than resolved as part of our identity as a solutions company for changing the way we think about our assortment and marketing strategy and aligning them more closely to how our key cohorts shop. We're creating more compelling customer-driven that provide a more holistic look and feel for Lands' End iconic American brand and the way these designs present and sell our products. We're 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 companies were using this new approach alongside our investments to drive more robust engagement with option cohorts for continuing to improve our site experience to 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 huge strategic infrastructure enhancements we've made to improve our internal efficiency. We've begun pivoting our IT focus to enhance our customer facing processes. We recently welcomed a new technology leader to spearhead these efforts and work with me to roadmap our strategy and identify leading partners to drive innovation consistent with our asset-light model.
Our facility in Baltimore solutions was a key driver of our strong performance this quarter, both in the US and internationally, we drove sales in key adjacencies, especially bottoms and sweaters. Our 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 US e-commerce business, US wind 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 products and centered around our classic touchless solutions 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 programs and Tupelo and developed building on the theme we've 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 US e-commerce business on 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 Tesco at the level we've had in recent years we are also continuing our efforts to maximize key events and holidays to drive demand with our customers responding well. This more targeted promotional strategy, which complements our broader strategy to minimize markdowns and show conviction in our solutions based category has led to improved margins.
Turning to our international business. As with our US business, our strong performance is driven by our authorities and transitional asset resolutions sent to prioritizing newness and improved inventory management. We delivered margins that were in line with our US business. Gross margin in Europe grew nicely by approximately 1,000 basis points year over year.
During Q3, we continued executing on our licensing strategy, which adds more mortality guarantees and new income streams, allowing us to continue to focus on our core capabilities. And recently we entered into a licensing agreement for all case categories, and we're continuing to ramp up activities under our existing agreements for Costco. And as I mentioned on our last call for footwear, we expect to begin seeing income from Phase 3 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 asset asset-based business, we are making headway in our efforts to enhance performance and ensure this critical business achieves the results were constant. They tend to be clear. We see great opportunity and profitably grow our share of open market certain business systems to help fuel our BCC customer acquisition engine 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 Health Care Corporation of America in the first quarter of 2024 outfitting 3,500 managers and frontline employees in parallel division.
Similarly, for expanding on the progress we made last quarter and our school uniform business through new relationships with large school districts that will ramp up in 2024. We continue to see schools as a key pipeline for Outfitters business and having achieved a 92% satisfaction rate among our existing partners this season, we believe we're well positioned to capture additional market share. We're driving innovation in our business with our planned introduction of integrated saving technology for celebrities in customer versus stores with plans to roll it out more broadly into provided by size that allows the purchaser to scan their body with BakBone 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 is the consumer experience. We're taking steps to drive efficiency across our B2B business through the process of reorganizing and revamping the organizational structure of our Outfitters 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. So business segment or in construction that will enable our teams to hyper focus on the needs of each customer group, working with our partners at Salesforce to enable a stronger data-driven sales process and also implementing marketing automation technology to improve customer communications, 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 and the deliberate approach we took to better tailor our assortments to each marketplace and the successful categories with a focus on quality of sales, improving gross margin, faster, inventory turn and freshness. The results were picked up tick with Macy's Target and Amazon performing consistently well with women as to where and swim driving demand across each of these marketplaces. With the holiday season underway, Valens and have launched an exclusive women's swim collection that target and select warm-weather doors. Beginning November 26, we'll roll out 200 total doors by early January 2024 for new swim collection includes nearly 70 pieces of our iconic stone, where a new fabrics trends and colors, including accessories. We're very excited to be partnering with Target to make our leading product category available to target customers. Bernie will then discuss our third quarter performance as well as our fourth quarter outlook. Following that discussion, we will share what we've seen so far in the holiday season before taking your questions.
Bernie McCracken
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 eCommerce 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 our gross profit dollars end markets. First margin in the third quarter was 47% and approximately 700 basis point improvement from the third quarter of 2022. Margin improvement was primarily driven by new products across the brand's 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 will focus on driving additional supply chain cost savings through product cost reductions and improved seasonal inventory management.
Our US eCommerce business saw a 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 key categories especially our outerwear solutions, new products across the brand and improved inventory management.
Sales in our Europe e-commerce business in the quarter were down 8% year-over-year, reflecting continued macro economic 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 adjusting for Japan, sales from Lands' End Outfitters were down 8% from the third quarter of 2022, excluding the $4 million decrease in year-over-year revenue from Delta for Outfitters business about 3%, primarily driven by high single digit growth in both our national accounts and midsize customers, more than offset by school uniforms 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 end target for 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, primarily due to approximately 400 basis points of deleverage from lower revenues at 145 basis points to higher incentive space personnel costs, partially offset by lower marketing and to 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 continue to evolve our digitally native business. For 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. The 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 capitalizable speed-to-market initiatives year to date, net cash provided by operations was $163 million greater than last year, primarily due to this improved inventory productivity.
In terms of our debt at the end of the third quarter, our total term loan balance was $234 million at our $275 million ABL had $110 million of borrowings outstanding, which was $15 million lower than the third quarter last year. Despite lower borrowings outstanding on the ABL, we've continued to have elevated interest expense driven by higher market rates. We're continuing to explore opportunities to finance our debt and are committed to doing so subject to favorable market conditions.
For the third quarter, we purchased 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 this 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 $27.5 million to $31.5 million, which takes into account SG&A impacts related to normalized compensation accruals.
Based on our third quarter results and quarter guidance we are 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 adjusted diluted loss per share of $0.16 to $0.07. We expect adjusted EBITDA to be in a 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 management will enable us to maintain inventory at normalized levels and bolster our work to further expand gross margin moving forward so that I will turn the call back over to Andrew.
Andrew McLean
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 we can see traffic ramp up as we progress through November, significantly stronger traffic and increased gross profit dollars across our channels on Black Friday and over the weekend had been Cyber Week. This holiday season. We are better engaging with our customers to our improved brand focus to drive higher-quality sales. So that's supporting our enhanced inventory position as we approach the end of our fiscal year. Like other retailers, holiday promotions are higher from across the balance of the year. However, we continue to scale those promotions back versus prior holiday periods and remain committed. So 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 file to drive profitable demand throughout the holiday season. However, we remain cautious given the weeks ahead and the additional weekend between Black Friday and Christmas, which could for some business later on beyond our shipping customer. As I mentioned earlier, we are confident that we have found a winning formula to achieve more productive sales by focusing on a better understanding of our customers' shopping behavior.
And then moving to inventory. Customer-centric strategy is working, and 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, well positioned to finish strong through the year.
That concludes our prepared remarks. We look forward to your questions.
Question and Answer Session
Operator
(Operator Instructions)
Dana Telsey, Telsey Advisory Group.
Please go ahead.
Dana Telsey
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 you planning that going forward. And then on, it's nice to see scaling back on the promotions and that you're seeing, especially post the Black Friday time period, what are you seeing in terms of categories, outerwear, how you plan a power A. was? And then on the margin focus, what are you seeing in terms of under the hood on the margins, whether it's sprayed or whether it's a Sea where what is the opportunity for the gross margin going forward? Thank you.
Andrew McLean
Big Data Center go in that area seems good to bump up leading into directly into the question that we continue to see opportunity for us on inventory and then pulling that back. We're going to work the business more to a churn and see an opportunity. We're moving the business between three and four turns. I mean, obviously, it gets harder as the turns increase where you're looking, but it's a function of the speed that we're putting into our supply chain. So we've talked a lot and it's going to be related to your AUR comment, your AUR comments as well. And we've talked a lot about getting speed in and having more freshness more consistently in the business month after month after month versus a more traditional model of buying twice a year. And that in of itself will give us more opportunity to increase the turns going into next year. And it will give us opportunity to show off and maintain the average unit retails. I'm going to talk to Bob scaling back promotions. We scaled back promotions even through Black Friday and Cyber Monday. Com. I just wanted to emphasize that point in the script, we it come into an early one of the things I've noticed about Lands' End is probably more to do with our cataloging history than anything else. So we really kick off holiday in October, October tends to be a bigger month for open August. So that's different than I've experienced in my career on. And it's really it's the start at the start of the holiday shopping period and holiday for us is really all about exit successful, October and November and then that last couple of weeks after Cyber Monday. So what you saw that really begin to market Black Friday in October are consistent with our styling holiday, and that's what's new in their insurance that the overall level of promotion they were following and they were falling consistently. It does take a lot of box. Our coffers that we've traditionally done. You will see us going up to 70% less pages of up to 7% growth. I thought we were up to 40% of that. Given that that's where we've started this. We sort of pull the needle out to in terms of where the problems arise. And we saw that that customer came with us on the journey, particularly when we offered newness in their farm. We noted in the call in Q three and it's been a it's been something we've seen all year that the women's categories were all posting double-digit comps and gross margin comps. And I wouldn't be fair to say that we've seen that continue. We've seen very successful acceptance of our product in those categories.
Answering your question about categories, you know, probably sort of worried not worried in that we took and we made some changes in how we approached as to where we are coming through last year. It was clear we were taking really our best stuff. Starts are down parkas we were discounting them. It gives credit for Black Friday, Cyber Monday, and it was just too much discounts. We've given that I felt we needed to take a different direction on that in addition to that, not to not, it's not not a political statement. Winters are getting warmer and they happen later. So we had changed the weighting of the fabrics and the products that we brought in really for the early part of holiday. So it was less about that heavy outerwear. I will tell you certainly needed in the Midwest today as we sit here in the snow, but even for the first five, six weeks, we really got behind other programs. We brought in a non than on Title issue late, but it's a vast program that's been very successful. It gave us a price point at a margin and actually fit with where the climate was that.
In addition to that, we brought in a new middleweight jacket. We've introduced new program, Wonder weight five and one. It's done so that it's pack and pull down and it's been a very successful. So entry price point into heavier, whereas heavier outerwear for us. So very pleased with how outerwear has performance fees that our women's has performed. And actually, we showed we showed that we thought categories alongside tag along for the ride. We saw good performance in men's and actually even our products like home less last year. And I remember this very clearly, we were discounting home very heavily. We haven't needed to do that. And actually on the one offer we gave, which was a $10 CPM Macau, which sold a lot of talent that day there was a pent up demand waiting for that last part of it as we think about them, as you see at the margin compensations, we've got a lot of our gains in Q3 from actually lower at lower discount rates. So the real benefit of the average of the cost work that we did a still to come to us, if you remember, we made the arrangement and made the changes in our sourcing organization to move to Li & Fung on that is a Q2 event. And we can have really even with the speed of our supply chain, you go to the full effect of that given inventory turns and so middle to back half of next year. So we still think that the best is to come in terms of continued margin upside from AUC. And that is kind of thing we started with it. And it's like women's is where we've seen the most progress as we expand that thinking to other categories. And we see that we will be able to continue that momentum as well. And that's the story we've stuck to Dana. We've stayed with it pretty consistently says I took over, I absolutely committed to it. I believe we'll get this done. And this is a this is a really great margin story that we have at Lands' End at the moment and really a reallocation of our product.
Bernie McCracken
And then, Dana, I'll 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 then you also receive benefit as soon as you have saw part of the announcement that we also announced another license, which case our licensing arrangements will also have a benefit, so reducing our inventories.
Dana Telsey
Got it. Thank you very much.
Andrew McLean
Thank you, Dana.
Operator
Thank you. Alex Fuhrman, Craig-Hallum Capital Group. Please go ahead.
Alex Fuhrman
Hey, guys. Thanks very much for taking my question on. So clearly, the focus online, prioritizing profitability over revenue is producing some nice results here. I'm curious how much more room you think there is pull back on unprofitable sales. Could there be another leg down of revenue as you identify more and promotions or clearance activity that you want to pull back on? And then looking out over the couple of years as you add more high-margin revenue, presumably from growing the licensing business and can you continue to grow EBITDA without necessarily a big increase in revenue. Can this be $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
Yes. So I'm not sure you've been sending 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 clearance sales and when we get out of the products we're not as focused on that and don't have authority online will be able to drive about a top line, we'll be able to drive a better profit and better net income number from a licensing arrangement. Then selling a lot of product at clearance of that we tended to do ask. So I think you definitely hit on that. We expect to be able to drive ultimately would have been $1.5 billion revenue company.
Andrew McLean
Saying that, Alex, as you know, as we look further out, but there is a point where we have the customer reeducate, and that's what's happening right now. I mean, the we have a customer deciles and our lowest lowest decile is the one that we have probably averaged the most customer that they lost the brands they're committed to the brand. You know, customers come and they stay with Lands' End for 17, 18, 19 years, what? They're not well, what they're struggling most to respond to it is that they traditionally use it a little bit like a stock option, which is like they put product in their basket and they wait until they get the price they want and then they'll buy it. We're moving towards customers who will buy the product now or it won't be there if we're not going to discount our product portfolio to spend on our brands, we're going to expand on what we believe are the key attributes of the lens and solution company that we have built, convert kind of drive that. I think what you will see and we're seeing ourselves further into our in our internal discussions is we're shifting from us are relatively simple decile based model that looks at all customers the same and we're moving towards a more thoughtful from a psychographic model that looks at customers in cohorts. And the two cohorts that we've identified are resolved with a goal of reserves. It would be fair to say that we've used the fourth quarter to start repositioning some of the thinking around them and how we go to market and to them how we sell to them what uniquely versus more generic place and how we track them on top of what we've been doing in Q4 and part of what we use Black Friday and Cyber Monday for us to go out and find new customers, new customers that we like, which is why? And then there was just some throwaway comments in the script, but it's why we talk so much about social media. We really like the customer we're finding from that. They fit our revolver platform and have had they are much less inclined to buy at a discount. So we're doing the hard work right now. The commitment you're getting from meet the commitment you're getting from this management team is that we're going to deliver gross margin comps. And this isn't just about getting rate and declaring victory. We understand we are here to drive EBITDA and ultimately earnings per share. And that's why we are very focused on that. So we're constantly evaluating that and surrounding that need 11 days be that Black Friday, Cyber Monday or just they cancel the Tuesday in January.
Alex Fuhrman
Okay. That's really helpful. Thank you. I appreciate your insights and congratulations again on the strong third quarter results.
Andrew McLean
Thank you.
Bernie McCracken
Thank you, Alex.
Operator
Thank you. This does conclude today's Lands' End third quarter earnings call. You may all disconnect at this time and have a wonderful day.
