Destination XL Group, Inc. (DXLG) Q1 2018 Earnings Report, Transcript and Summary

Good day ladies and gentlemen. And welcome to the First Quarter 2018 Destination XL Group Incorporated Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference maybe recorded. I would now like to introduce your host for today's conference Tom Filandro, Managing Director at ICR. Sir, you may begin.

Thank you, Monee and good morning, everyone. Thank you for joining us on Destination XL Group's first quarter fiscal 2018 earnings call. On our call today is David Levin, our President and Chief Executive Officer; and Peter Stratton, our Executive Vice President and Chief Financial Officer. During today's call, we will discuss some non-GAAP metrics to provide investors with useful information about our financial performance. Please refer to our earnings release, which was filed this morning and is available on our Investor Relations Web site at investor.destinationxl.com for an explanation and reconciliation of such measures. Today's discussions will also contain certain forward-looking statements concerning the company's operations, performance and financial condition, including sales, profitability, EBITDA, adjusted EBITDA, gross margin, marketing costs, capital expenditures, earnings per share, free cash flow, store openings and closings, the corporate restructuring and related cost and savings and the company's ability to execute on its strategic plan. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those assumptions mentioned today due to a variety of factors that affect the company. Information regarding risks and uncertainties is detailed in the company's filings with the Securities and Exchange Commission. Now, I would like to turn the call over to our President and CEO, David Levin. David?

Well, thank you, Tom, and good morning everyone. There are few topics I would like to discuss today. First, I'm going to give a quick recap of our first quarter business performance. As many of you saw in our press release this morning, our sales momentum from the fourth quarter continued into fiscal 2018 and our earnings for Q1 have improved significantly from Q1 of last year. We're encouraged by what we are seeing in the business today, and we believe we have some strong opportunities still to come in the second half of the year. There's an update. May has been a stellar month with comp sales anticipating to be in the mid-to-high single digits. Second, I will discuss our plan to improve our operating margins. Two weeks ago, as reported, we initiated a corporate restructuring to accelerate our path to profitability. As a result, we expect annualized cost savings of approximately $10.3 million. The bulk of these savings are from actions taken on or before May 16 when we eliminated 56 positions or 15% of our corporate office workforce. And we'll also discuss our strategic priorities for the remainder of the year and provide an update on our progress against our goals. Finally, I'm very happy to report that on May 24th, we entered into a new senior secured credit facility with our bank group. Peter is going to discuss with you the terms of the deal, but overall our pricing under the new facility is better than the prior facility. Not only will we benefit from the improved terms, we feel this agreement demonstrates confidence on the part of our lenders and our business and then our financial plan. Now our Q1 performance. I'm pleased to report that we delivered positive comparable sales growth of 2.2% for the first quarter. Other than a three-week period at the beginning of April, where much of the country experienced unseasonably cold weather, and we had yet to launch our spring marketing campaign, our sales results were right in line with our expectations. Once again, our store associates executed on delivering outstanding in-store experiences with exceptional service, leveraging our unique selection and fit. And despite the slightly negative in-store traffic, our first quarter store productivity was driven by healthy growth in shopper conversion with an increase in the number of transactions and a slight increase in dollars per transaction. In our direct business, site usability and more powerful storytelling enhancements are continuing to increase engagement and conversion rates, particularly in the mobile space. On a trailing 12-month basis, our direct business now accounts for 21.2% of sales compared to 20.2% a year ago. We also continue to see very nice gains from marketplaces, which include Amazon and walmart.com. Now that a large portion of our assortment is available on Amazon Prime with two days shipping, we saw a doubling of our business during the first quarter and we continue to see that the majority of the transactions generated are from customers who have never shopped in our stores or on our site. Our gross margin was slightly less than we expected, particularly in our direct business due to promotions, shipping costs, and free shipping offers. We're currently evaluating all of our shipping offers and benchmarking key competitors to find the right balance of meeting customer expectations while minimizing our shipping costs. We feel confident that some minor changes to our shipping and warehousing strategies, as it relates to our direct business, will bring our margins back in line with our expectations during the second half of the year. I'm also pleased to report that we more than doubled our EBITDA in the first quarter to $5.1 million from $2.5 million in the first quarter last year. Our SG&A expenses for the quarter were in line with our plan. Our advertising costs were down approximately $1.6 million for the quarter as we planned due to the launch of our national marketing campaign on April 26 this year compared to April 2 last year. Overall, we had solid performance in the first quarter and feel our business is progressing as we expected. Now, I'd like to shift gears and discuss our plan to improve profitability. In particular, we'll talk today about the four major pillars of our strategy. One, managing our cost structure; two, focusing on our customer; three, improving our return on investment on our marketing and digital initiatives; and four, enhancing our in-store experience. Our first step is managing our cost structure. With our store build out largely complete, we are more focused than ever on improving our operating efficiency. For the past six years, the company has operated at a net loss and we recognize that our company needs to show a better return on investment. Our EBITDA, as a percentage of sales in fiscal 2017, was 3.7% and we know that's not good enough. We know we need to get to profitability and that starts with bringing our costs in line with our current sales level. As I mentioned, on May 16th, we eliminated 56 positions including four Senior Vice President positions. At the end of fiscal 2017, we had 2600 employees across the country which included approximately 375 corporate positions. The elimination of 56 positions amounts to a 15% reduction in our corporate workforce. One of the strategies behind this restructuring was to create a smaller, more focused executive team. The number of direct reports to the CEO [ph] has decreased from 8 to 5. We believe this new structure will be more efficient and allows to improve coordination and communication among our core business units and focus on key business drivers. Additionally, we are reducing non-customer facing costs such as corporate travel, benefits, and non-essential projects. We are acting with decisiveness to right size our cost structure. Of all the planned actions expected to contribute to the $10.3 million of annual savings, three quarters will be completed by July 1. For fiscal 2018, we expect to realize savings of approximately $5.6 million, $2.4 million of which was already factored into our previous earnings guidance when we announced our Q4 2017 results. The last comment I want to make about our cost restructuring is that the decisions and outcomes of these exercises were grounded in the benchmark comparison process. We enlisted the help of a well-known third party consulting firm to assist us in evaluating each functional area of our SG&A expense base. We benchmarked ourselves against other specialty apparel retailers and conducted a rigorous process that we feel yielded a successful outcome. The second step of our plan is to become laser focused on our core customer. We're finishing up our first ever segmentation study of the big and tall market and this data will help us understand the different segments in the market and allows to focus on the most critical segments to grow our business. From marketing and product development standpoint, we'll focus on the biggest, most attractive group of consumers that can quickly help build our business. In particular, we already know that the top 5% of our customer base generates 30% of our sales and we will focus on that group to quickly grow our business. Our third step is to create a better ROI on our marketing and digital investments. On the last call, we announced the hiring of Jim Davey as our EVP and CMO. Jim comes from Timberland and has extensive experience in growing both traditional and digital businesses. Part of our restructuring plan involves centralizing e-commerce customer analytics, digital marketing and brand marketing under one department. We believe consolidating responsibility under Jim will allow to deliver a better customer experience and higher engagement across all of our offline and online touch points. In particular, Jim and his team are driving four important initiatives. One, CRM; we capture over 90% of all our sales within our loyalty program. This gives us extensive consumer data which we can use to personalize our communication to all customers. To accelerate this opportunity, we'll be investing in an upgraded CRM system in Q3, which will allow us to better leverage this important data. Two, a new site launch. We're on track to launch an upgraded mobile and desktop e-commerce site during Q2. The new site provides a cleaner more intuitive experience for our customers and allows them to quickly find what they're looking for. It also allows us to launch a suite of analytical tools connected to the site that will allow us to quickly gather site data and make on the fly adjustments. Three, new creative strategy, our new campaign launch in late April during the NFL draft is getting strong feedback from consumers and driving sales. The campaign strategy comes directly from consumer research. It identifies fit selection in the in-store shopping experience is what matters most to our customers. Our tagline built to fit, built to excel, delivers this message perfectly and our connection to sports and athletes via strategic allies like ESPN is making the DXL experience more aspirational for XL guys who may not have considered us before. Four; finally, we're developing new tools both internally and with outside help to better understand the ROI and all our marketing programs. This will ensure that we've got the right mix of programs that are engaging our current customers as well as recruiting new customers to build the growing pipeline of business. Finding our target segments via our segmentation study and communicating to those segments with what is important to each specific segment will also improve our overall marketing ROI. The last major strategic pillar is enhancing the store experience. We have 231 DXL store today with another 103 Casual Male stores and five Large XL stores. Our store portfolio covers every major metropolitan market in the continental United States and almost all of our stores are generating a positive four wall cash flow. Our physical stores continue to bring the full DXL experience to life to represent both the customer, retention and acquisition tool. That said, we recognize the importance of offering a truly integrated omni-channel level of service allowing our customers to shop in whatever way they wish. To support our omni-channel strategy, we're improving our point-of-sale technology making it easier and faster for associates to access and sell inventory that reside outside of our stores four walls. We call this the universe and our associates are doing an excellent job of utilizing our web portal to drive incremental sales that in the past may have been lost sales. In the past purchasing items in-store and seeking to make online orders for items not present in the store was a Labor project requiring two transactions at a minimum. We recognize that this was frustrating for our customers and sales associates alike. The new technology allows all of the purchases to be made as one seamless transaction at the counter. And as a result, we're seeing a nice trend that our web portal business and plan to further fine tune and leverage this new technology as the year unfolds. And with that, I will now pass the call over to our CFO, Peter Stratton who view our financial performance. Peter?

Thank you, David, and good morning, everyone. I'd like to start this morning with a brief summary of our financial results. For the first quarter, net sales increased 5.3% to $113.3 million. This increase was driven by a comparable sales increase of 2.2%, a non-comparable sales increase of $3.2 million. We were very pleased to deliver another quarter of positive comparable sales with growth in both our stores and direct channels. And we are encouraged by the trends we're currently seeing in the business. Gross margin for the first quarter inclusive of occupancy costs was 44.7% as compared to a gross margin rate of 45.2% for the first quarter of fiscal 2017. The 50 basis point contraction in our gross margin was below our expectations and was due to a decrease in merchandise margins of 120 basis points partially offset by a 70 basis point improvement in occupancy costs. As David already mentioned, the decrease in merchandise margin was related to increased promotional activity specifically in our direct business as well as an increase in shipping costs. We are currently underway with a comprehensive review of our distribution and shipping strategies and we believe we will bring our margins back in line with some minor adjustments to our direct promotional and shipping offers. Our SG&A as a percentage of sales improved by 270 basis points for the first quarter to 40.2% as compared to 42.9% for the first quarter of fiscal 2017. On the dollar basis, our SG&A expense for the first quarter decreased by approximately $600,000. The lower spend was due to a decrease of $1.6 million in marketing costs primarily due to launching our spring campaign at the end of Q1 this year compared to the beginning of April last year. The lower marketing costs were partially offset by increases over last year in DXL store counts and other supporting costs associated with our stores in e-commerce initiatives Our adjusted EBITDA for the first quarter was $5.1 million or more than double the $2.5 million in EBITDA for the first quarter of fiscal 2017. The significant improvement was driven by sales growth as well as lower marketing costs. Before I move on to balance sheet highlights in our cash flow results. I would like to provide a few more details regarding our SG&A expense structure and how that structure is going to be impacted by our corporate restructuring. First, we manage our SG&A costs within two functional categories which we think of as customer facing or corporate supporting. The majority of the restructuring is affecting positions and programs that we consider corporate supporting costs. This includes adjustments to corporate staffing levels, corporate benefits programs, travel plans and other non-essential program costs. Our corporate supporting costs represented 17.3% of sales in the first quarter and we expect this number to improve as we realize the benefits from the restructuring over the coming year. The area that was less impacted by the restructuring is what we consider customer facing costs. This would include functional costs such as marketing, which we target at approximately 5% of sales, store payroll which we target at approximately 13% of sales in other store four wall costs which we target at approximately 5% of sales. In the first quarter, our customer facing cost in total represented 22.9% of sales. If you subtract our customer facing costs for the first quarter of 22.9% from our gross margin of 44.7%, the resulting four wall contribution would be 21.8%. In a few minutes, I'm going to provide an update on our full guidance for the year. But before I do that, I want to explain how our EBITDA guidance for the year is being impacted by the restructuring. As David mentioned, we expect to realize annual savings of $10.3 million as a result of our corporate restructuring. Of the $10.3 million, we expect $6.6 million to come from corporate staffing changes, $2 million to come from changes to defined contribution plans and $1.7 million from other non-essential general administrative costs. Let me also be clear with how the savings are expected to impact fiscal 2018. Of the $10.3 million, we expect to realize $5.6 million of savings in fiscal 2018. It's important to note that approximately 25 of the 56 position eliminations which account for $2.4 million of savings were identified in Q4 of last year and those savings were factored into our original guidance. Therefore, our updated EBITDA guidance that we are announcing today includes an increase of $3.2 million from the restructuring. Now let me turn to our balance sheet and cash flow. Cash flow from operations for the first quarter was negative $5.8 million and our free cash flow was negative $9.1 million. First quarter capital expenditures of $3.3 million were 50% lower than last year primarily due to fewer store openings. It's worth noting that this result was in line with our expectations. Every year in the first quarter, we expect an outflow of cash as we experienced a seasonal buildup of inventory ahead of Father's Day as well as an increase in prepaid costs due to our spring advertising campaign with some fluctuation in the timing of our accounts payables. Inventory at the end of the first quarter was up $2.9 million compared to Q4, but was down $15.2 million compared to last year. This substantial inventory reduction was once again a direct result of continued inventory initiatives that we've been pursuing since 2016 to improve timing of receipts and weeks of supply on hand. Our clearance inventory as a percentage of total inventory is in good shape at 9.7%. Total debt at quarter end was $70.3 million, which includes borrowings under the revolving credit facility of $58.9 million with access availability of $32.7 million. This compares to $78.8 million of total debt a year ago with excess availability of $45.7 million. This brings me to a topic that we are very pleased to announce today. Effective last Thursday, May 24, the company entered into a new $140 million five-year secured credit facility with Bank of America NA. We felt this was an opportune time to refinance our facility for another five years with an improvement in terms. The credit facility includes a $125 million revolving loan facility and a $15 million first-in last-out term facility. Under our previous facility, the revolver was priced at LIBOR plus 150 to 175 depending on our excess availability. Our new revolver which is structured with the same excess availability threshold is priced at LIBOR plus 125 to 150 or an improvement of 25 basis points. The FILO facility which was used to payoff our term loan with Wells Fargo is priced at LIBOR plus 275 to 300. This compares to our term loan which was priced at LIBOR plus 650 or an improvement of 350 to 375 basis points. Overall, we expect favorable pricing under the new credit facility will save approximately $700,000 in interest expense on an annual basis. A key point that I want to make about the credit facility is that this transaction did not increase our debt levels rather we extended our term for another five years with favorable pricing. We've been fortunate to have a great relationship with our bank group over the years and this agreement demonstrates the confidence that our banks have in the company. Now for an update on our guidance. We are revising our earnings guidance for fiscal 2018 to reflect the $3.2 million expense savings that we expect from the corporate restructuring. We are also revising earnings guidance to reflect severance and restructuring charges of approximately $1.7 million and $4.2 million in costs associated with CEO transition. Our revised guidance for fiscal 2018 is as follows; sales of $462 million to $472 million with the total company comparable sales increase of approximately 1% to 3%. Gross margin rate of approximately 44.5%; net loss on a GAAP basis of $13.2 to $18.2 million or $0.27 to $0.37 per diluted share; EBITDA adjusted for restructuring charges and CEO transition costs of $20 million to $25 million; capital expenditures of approximately $11.4 million which includes $9.3 million for digital and infrastructure projects; cash flow from operating activities of $20.5 million to $26.5 million including tenant allowances resulting in positive free cash flow of approximately $9.1 million to $15.1 million. This concludes our prepared remarks. And we would like to open the call for questions.

Thank you. [Operator Instructions] And our first question comes from Alex Silverman with AWM Investments. Your line is now open.

Hey good morning.

Good morning.

Just wondering if you could give us a little -- some more detail around some of the changes on the direct e-commerce business that impacted both margins, I guess sales margins and shipping?

Well, on the shipping costs -- the shipping side of it, a lot of it has to do with where we set the threshold for free shipping, and that's something we're working on right now to manipulate the numbers, so we can still offer free shipping to our best customers but cut back to customers that aren't as loyal and are lower profitable customers for us. So that's certainly one of the areas on shipment. As far as the promotional activity that we've been a little -- we were a little more promotional than we were a year ago, more customers are taking the promotional price points, and that's something we're adjusting going into the back half of the year also. So we think the drop in the margin rate on direct will have that neutralized back half of the year.

Sorry, just one of the things that I would add to that is on our shipping costs, more and more frequently over the last couple of years we are shipping more from stores and we do have some new software that's going to be deploying in the fall that's going to allow us to be more efficient with how we direct shipments coming from specific stores. So what we want to avoid is stores from one side of the country fulfilling an order on the other side of the country, and this upgrade to software is going to allow us to be much more efficient at that.

Makes a lot of sense. And this is -- you made a comment about Amazon Prime fueling sales. This is not related to neither the promotional pricing on merchandise nor shipping is related to that.

Well, the shipping is because to get the requirements in two days, it's more expensive to do that. But promotionally no, there are no – the prices you would find on Amazon are no lower than you would find in our stores.

Okay. That's helpful. Thank you. Second question, did you say $4.2 million for CEO transition?

Yes. That's correct.

And always what's -- I mean it sounds a lot of money for transition. How are you spending $4.2 million?

So, just a couple of comments on that. First, I'd like to point out that David has agreed to stay on with the company to ensure a smooth transition to the next CEO, and we expect at some point this year that David will separate from the company, and his departure would be governed by the terms of his transition agreement, which was filed in an 8-K a couple of months ago and his employment agreement. The company is also incurring expenses this year to retain a search firm. We're conducting the search, incurring other costs ultimately to install a new CEO. So, I'm not going to get into specifics about what makes up the $4.2 million, but our best estimate right now is all of these costs that we're incurring to ensure a successful and smooth transition. Our best estimate right now is that it's $4.2 million.

I mean that sounds to me like severance.

Well, again, as part of David's employment contract, he would be entitled to certain separation benefits, but that's only one piece of the $4.2 million.

I thought David was retiring.

David again -- David has a transition agreement that we have filed and you can refer to that for the specific terms of this separation, but we are accruing according to the terms of those agreements.

I find that to be somewhat egregious just so you know?

Understood. Thank you.

Thank you. And our next question comes from [Harvey Henner with Orkney] [ph]. Your line is now open.

I have I think two specific questions that I'm a little confused by. The first Peter is, under capital expenditures, the $9.3 million for digital and infrastructure projects, are those capitalized or are those expensed?

Yes. So those are – that’s part of our capital expenditures for the year. So every year we incur costs CapEx related to infrastructure systems implementations and so forth. That number typically runs between $8 million -- in the past, it's been $8 million to $10 million a year. I expect that normalizes at more like a $6 million to $8 million number a year. This year, we certainly have some big projects that are coming on. We have a new site being deployed in the second quarter, and we have some additional operating management system and warehouse management system, which is the back end of the Web site that we'll be deploying in the fall. So to answer your question, that's capital.

Okay. And approximately what -- over what time period is that amortized or depreciated?

Typically, that's amortized over five years.

Okay. Thank you. The second question is -- and I know you've discussed this -- a lot on this call and in other calls, but I'm still confused by it. The amount of savings that you're going to realize from the changes to your SG&A as you described on this call. If we were to look at what you projected at the beginning for 2018 before this initiative, but including the vacant positions that you’ve described, what would be the change for a new year? So in other words, if 2019 would be exactly the way you projected 2018 at the beginning of 2018, what would it look like, I mean would it go from $20 million to $25 million of EBITDA to $30 million to $35 million in EBITDA apples-to-apples. What would that look like? So there are so many numbers that are moving around that I just don't get it.

I understand the question because you are right. There are a lot of numbers, so let me try to answer it as -- I will try to make it as simple as I can. So, the total number of annualized savings is $10.3 million. We had included $2.4 million in our original guidance. So if you are thinking about year-over-year how much is that account for, the old number included $2.4 million, the new number would be $10.3 million, so the incremental amount on an annualized basis would be $7.9 million.

Okay. So, if you project it and I believe it was $20 million to $25 million, I could just add that $7.9 million if I just wanted to say okay. The business is now capable of sustaining this at the same level of operations with fewer costs?

Yes. I think that's a fair statement.

Okay. Well, thank you very much and continue on a positive trajectory.

Thank you.

Thank you. [Operator Instructions] This concludes today's Q&A session. Ladies and gentlemen, thank you participating in today's conference. This does conclude the program. You may all disconnect.