Destination XL Group, Inc. (DXLG) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Third Quarter 2018 Destination XL Group Inc. 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 call maybe recorded. I would now like to introduce Ms. Lisa McKee [ph] on today’s conference. Ma’am you may begin.

Thanks, Lauren. Good morning, everyone. Thank you for joining us on Destination XL Group’s third 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 website at investor.destinationxl.com for an explanation and reconciliation of such measures. Today’s discussion also contains 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 costs 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?

Thank you, Lisa and good morning everyone. I am pleased to report that our third quarter financial results represent another solid quarter of sales growth and improved earnings performance. This was our fourth consecutive quarter of positive comp sales growth and the momentum that we started to experience in the fourth quarter last year has continued through the spring and fall selling seasons. Earlier this year, we launched an aggressive plan to reduce our SG&A expenses without sacrificing sales, and I’m happy to report that we are well on our way to achieving that goal. As highlighted in our press release this morning, we increased our comp sales by 3.4%, more than doubled our adjusted EBITDA from $2.8 million to $6.6 million and we are raising our fiscal year 2018 guidance. We remain well positioned for the all important holiday season and are confident our momentum will continue into 2019. This morning I will briefly discuss our third quarter performance and update you on the progress we are making on our strategic priorities before turning the call over to our CFO, Peter Stratton, for a more detailed discussion of our financial performance. Now our third quarter performance. As I mentioned, our comparable sales for the third quarter increased 3.4%. We saw particularly strong sales in the Northeast and Southeast, but all of our regions across the country saw positive comp sales increases. The performance was ahead of our expectations and due in large part to an improvement in traffic to our DXL stores. We’ve been battling declines in store traffic for much of the year, but traffic in the third quarter to our DXL stores flattened out. Our store associates are experts at leveraging our unique merchandise selection and fit to deliver outstanding in-store experiences which contributed to improvements in both conversion and dollars per transaction. We continue to view the broad growth in our comp metrics as a signal of strong brand and product acceptance as well as store level execution. In our direct business, the highlight of the quarter happened in September when we launched our new and improved website. The new website offers a much cleaner look and feel, easier navigation and streamlined checkout. We’d be cluttered the visual merchandise presentation and updated creative content which not only showcases the uniqueness of both our branded and private label offerings, but also enhances the look and feel of the DXL brand. Site functionality also improves with better navigation for customers to find what they are looking for quickly and easily especially within our mobile experience. The improvement in site usability and elevated storytelling sets the stage for accelerated performance over the holiday season across all of our digital platforms. These improvements will allow us to engage more meaningfully with our current customers as well as bring in new customers. We also continue to see very nice gains in our direct business from our third-party marketplaces, highlighted once again by Amazon which more than doubled in Q3 as compared to last year. Marketplaces are still a small percentage of our overall direct business, but remain the fastest growing segment of our direct channel. Most of our assortment offered on Amazon and is offered to the Prime program with 2 days shipping. We continue to see that the majority of the Amazon transactions are from customers who have never shopped in our stores or on our site, a clear indication that we are expanding the DXL market reach. Gross margin was ahead of our expectations and reflected a lower level of promotional activity coupled with occupancy leverage as a result of our positive comp. One of our core strategies is to shift consumer focus to comfort, style and fit. We know comfort and fit is of paramount importance to our guests and we believe we understand comfort and fit better than anyone in the big and cloud sector. Promotions will always have a place in our business model, but we believe leveraging comfort and fit is an opportunity that we are building around going forward. We’ve also made some progress in the third quarter with managing freight and shipping costs. Last quarter, we talked about how we are seeing some margin pressure from escalating shipping costs. We are pleased to report that we’ve taken a number of steps operationally to mitigate those costs. One way we are managing this risk is by reducing the number of stores eligible to fulfill direct orders and they are shift from store fulfillment model. This change has led to a reduction in clearance sales, which is translated into an increase in sell-through and full-priced product. Another benefit we’ve realized is the average number of shipments per order has declined with fewer stores shipping to the customer remaining fewer split shipments and therefore becoming more efficient. We’re still seeing cost pressure from the freight carriers, but we’re confident that there operating tactics that we can use to mitigate some of that pressure. Turning to our merchandise assortments, I’m very excited about the progress we’re making. Over the past year, our guests have been telling us that they want more fashion choices and our merchandise analytics showed a distinct uptick in fashion preferences over core basic choices. As we built our fall product lines, there was a deliberate effort by our merchandising team to infuse more fashion into our assortment. And a great example is our private label brand, Harbor Bay. The fall line for Harbor Bay is loaded with more prints and bolt patterns represent a departure from our traditional solid colors. And we are also very excited to have launched two new outstanding brands with the North Face and Vineyard Vines. Demand for the North Face has far exceeded our expectations and our early reads for Vineyard Vines indicate this is another strong brand that resonates with our customers. Now shift to an update on four main strategic pillars which anchor our plan to improve profitability. Now as a reminder, the pillars are; one, managing our cost structure; two, focusing on our core customer; three, improving our return on investment and our marketing and digital initiatives; and four, enhancing our in-store experience. Rightsizing our cost structure represents a significant step on our path to improving profitability and we are on track with our previously announced cost restructuring plan, which not only reduced our corporate workforce by 15%, but created a smaller more focused executive team by reducing the number of direct reports to the CEO. Across our business units, we are seeing the benefits of the streamlined corporate structure. There’s greater coordination and communication with a clear focus on key business drivers. Second step of our plan is to become laser focus on our core customer. As we discussed on our second quarter call, we completed a customer segmentation study to understand the different segments and customers in the big and tall marketplace. We’ve identified a segment we’re calling the fit and style segment which makes up 14% of the market, but represents 40% of all spending. He’s a guy who cares about fit, but he also cares about style, and he loves the products, brands, and shopping experience that DXL offers, and most importantly, his yearly apparel purchases are three times that of a typical big and tall customer. During Q3, we began taking these insights and developing marketing programs to cater to this particular customer. We launched the test catalog in early November that was targeted to these high value customers. And the catalog showcases our new creative strategy and launches DXL’s new premium look and feel which can also be seen online and in-store and at all DXL touch points. Reactions from customers to this new lifestyle photography, new models, new fashion fields has been terrific. We’ll be adding seasonal catalogs to our mix of advertising spend in 2019. We also learned that in the social space this customer primarily files athletes and in particular pro football players. So we launched a digital content campaign with former pro football stars Brian Urlacher and Vince Wilfork who we have captured a day of shopping which each of them at the DXL store. This content will be used across our social channels and our e-commerce site and through direct and email programs. Both superstars showcase a range of specific looks that will really appeal to our target audience. The content also includes specific directions and where to find the product online for in-store. The third step is to create a better ROI on our marketing and digital investments. As of Q3, we’ve launched a suite of new modelling tools which will allow us to understand which elements of our marketing mix hits higher or lower ROIs. We can then take this information to define the right level of marketing spend as well as the optimal mix to drive traffic and sales. This is an important pillar in our overall strategy of aggressively using predictive analytics help guide our marketing initiatives. Our last major strategic pillar is enhancing the in-store experience. At the end of last year, we tested a new real estate strategy of remodeling selected Casual Male stores and rebranding those stores with DXL. This is a departure from our previous strategy of relocating and increasing the square footage at a cost that was typically 3x more than remodeling an existing Casual Male store. In Q2 of this year, we’ve completed our fifth remodel store in Middletown, New York. And what I love about these remodel stores is that we’ve upgraded the product assortment and the in-store experience and we could do it far cheaper than if we were to go out and secure new real estate. So far we’ve been very pleased with the sales lift these stores have seen post remodeling and we are now planning to roll out an additional 10 remodel stores next year. Remodels provide a low cost, high growth alternative for our Casual Male store portfolio and also provide a pathway for unifying our Casual Male store base under the DXL brand. With 231 DXL stores, 98 Casual Male stores and five Rochester stores, our brick-and-mortar store portfolio covers every major metropolitan market in the continental United States. And with that, I will now pass the call over to our CFO, Peter Stratton, who will review 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 third quarter, net sales increased 3.2% to $107.1 million. The increase was due to a comparable sales increase of 3.4%, an increase of $700,000 in non-comparable sales from DXL stores opened less than 13 months, an increase of $300,000 in other revenues and $700,000 shift in calendar weeks due to the 53rd week in fiscal 2017. These increases were partially offset by closed stores that contributed $1.7 million to sales last year. Gross margin for the third quarter inclusive of occupancy costs was 44%, as compared to a gross margin rate of 43.2% for the third quarter of fiscal 2017. The increase of 80 basis points was due to a 90 basis point decrease in occupancy costs as a percent of sales partially offset by a 10 basis point decrease at merchandise margins. The decrease in merchandise margin was due to a slight shift and lower sales penetration from our private label brands and higher sales penetration from our designer brands. Occupancy costs as a percentage of sales improved from leverage on higher sales base and a decrease of $300,000 primarily related to closed stores. Our SG&A as a percentage of sales improved by 270 basis points for the third quarter to 37.8% as compared to 40.5% for the third quarter of fiscal 2017. On a dollar basis, our SG&A expense for the third quarter decreased by $1.5 million. The decrease was primarily due to a reduction in payroll and payroll-related costs. We manage SG&A expense through two primary cost centers, Customer Facing Costs and Corporate Support Costs. Customer Facing Costs, which includes store payroll, marketing and other store operating costs represented 21.6% of sales in the third quarter of fiscal 2018, as compared to 22.4% of sales in the third quarter of last year. On an annual basis, we continue to target marketing expenses at approximately 5% of sales. Corporate Support Costs, which include our distribution center and other corporate overhead costs represented 16.2% of sales in the third quarter of fiscal 2018, compared to 18.1% of sales in the third quarter of last year. We are continuing to address our SG&A cost structure with an eye to improving our EBITDA margins and overall profitability. As a reminder, we initiated a corporate restructuring in May that resulted in the elimination of 56 positions or 15% of our corporate workforce. On an annualized basis, we are still on track to deliver approximately $10 million of annualized savings, which will be realized through the remainder of fiscal 2018 and the first half of fiscal 2019. Our adjusted EBITDA for the third quarter more than doubled to $6.6 million compared to $2.8 million for the third quarter of fiscal 2017. The improvement was driven by comparable sales growth, as well as reduced SG&A expenses related to lower payroll-related costs as a result of the restructuring. Our adjusted EBITDA results exclude restructuring costs such as severance and CEO transition costs. Now let me turn to our balance sheet and cash flow. Cash flow from operations for the first 9 months of the year was negative $1.3 million. Our free cash flow was negative $11.1 million, an improvement of $2.1 million from negative $13.2 million in the first 9 months of 2017. The improvement from 2017 is due to higher 2018 adjusted EBITDA and lower CapEx spend partially offset by working capital changes that were more favorable in 2017. Capital expenditures of $9.8 million were 47% lower than last year, primarily due to fewer store openings, but we have had an increase in our IT CapEx spend due to the build of our new website and an ongoing project to upgrade our order management system and warehouse management system. Inventory at the end of the third quarter was down $3.5 million compared to last year and is down $11.8 million from 2 years ago. This substantial inventory reduction is the result of inventory initiatives that we’ve been pursuing since 2016 to improve timing of receipts and weeks of supply on hand. Our clearance inventory is in good shape. As a percentage of total inventory, clearance is up slightly at 11.7% compared to 9.7% last year. We believe this is due to more customers gravitating towards our new full price fashion choices in the fall assortment. Last year, we were seeing higher sell-throughs in clearance product, while this year we have enjoyed more sales at full price. Total debt at quarter end was $72 million, which includes borrowings under the revolving credit facility of $57.3 million with excess availability of $45.4 million. This compares to $81.4 million of total debt a year ago and $43.3 million of excess availability. Despite the reduction in total debt, our availability hasn’t increased proportionately because of our lower inventory levels which affect our borrowing base. Lastly, we are increasing our guidance for fiscal 2018, which reflects the sustained sales momentum we’ve experienced this year combined with the savings that we expect from the corporate restructuring. Our earnings guidance also continues to reflect severance and restructuring charges of approximately $1.9 million of which $300,000 was recorded in Q3. The company expects to incur approximately $3.7 million for CEO transition costs with $2.1 million projected in fiscal 2018 and $1.6 million projected in fiscal 2019 and 2020. Our updated guidance for fiscal 2018 is as follows; sales of $470 million to $474 million with the total company comparable sales increase of approximately 2.5% to 3.5%, an increase from our previous range of $462 million to $472 million; gross margin rate of approximately 44.9%, a 40 basis point increase from our previous guidance; net loss on a GAAP basis of minus $9.8 million to minus $12.8 million or $0.20 to $0.26 per diluted share, an improvement from our previous guidance of $0.27 to $0.37 per diluted share; EBITDA adjusted for the restructuring charge and CEO transition costs of $24 million to $27 million, an increase from our previous guidance of $20 million to $25 million; capital expenditures of approximately $12.5 million, an increase from our previous guidance of $11.4 million; and cash flow from operating activities of $22.5 million to $26.5 million including tenant allowances and positive free cash flow of approximately $10 million to $14 million. Lastly, I will turn the call back over to David for an update on our CEO search.

Thank you, Peter. As you may recall, last March, the company announced that I plan to retire on December 31, 2018 and that Heidrick & Struggles was engaged to lead a search process to identify my successor. That search process was canceled in October. The company has engaged Russell Reynolds to lead a new CEO search process, which we expect to be completed by the end of the first quarter of fiscal 2019. You may recall that there is a transition agreement between the company and me. And under that agreement, I will resign as an Officer and Director of the company on January 1, 2019. And the company announced this morning that has entered into a letter agreement with me such that, if there is not a new CEO in place by December 31, 2018, I will assume the role of acting CEO from January 1, 2019 through April 30, 2019, and in addition, the Board does have the option to extend the arrangement through June 30, 2019. That concludes our prepared remarks and we’d like to open the call for questions.

Thank you. [Operator Instructions] And our first question comes from Eric Beder with Small Cap Consumer Research. Your line is now open.

Good morning. Congratulations on a solid Q3.

Thanks, Eric.

Thank you.

Could you talk a little bit about the Casual Male stores you’re converting into Destination XL’s. I know one of the uses of Destination XL was to bring in new customers and kind of move the area around. Are you still seeing that influx of new customers in these converted stores?

Yes, it has been consistent and as we’ve pretty well matured out the DXL expansion, we said, we still have 98 Casual Male stores and we think there are about 30 to 40 of them that have enough space and the locations are viable that rather than move the location and expand it to a much bigger box we could take the existing store and just basically remodel it and introduce the elevated brand products that we have from the DXL store and get a much better benefit with really a minimal amount of capital – CapEx and we’re getting some tenant allowance from the landlord to execute this. And again we have done 5 of them. They are doing very well in terms of ROI. So we think we’ve got the 30, 40 more to go and the remaining Casual Male stores will continue to stay open as long as they contribute significant cash flow to help support the rest of the company.

Great. And when you look at it, you added two key new brands to the mix there. Where are you significant level of brands that you want to add that your customers are asking for that they don’t have right now and you know when you add the new brand here, do you basically rotate out some older brands or is it just kind of spread it around. How do you look at that?

It’s a combination for example, when we talk about our strong brands in outerwear with Columbia and now with the North Face, that was a private label business for us, but we’ve seen a dramatic increase when we took when we moved those into brands so that really it’s been very successful for us so not that we do that as far as dimensioning out more brands we are – our house is full we have got over a 100 brands right now and if one comes in probably one will fall out but as of today there’s we’re working on one more denim brand for a launch next year we are very excited about, we’ve been working on that for many years but other than that, we are in great shape with all the brands that we could ever have imagined.

And custom suiting and suiting, how is that business doing? In general hear things that that’s been a very strong brand for some of your competitors. How are you looking at that business going forward?

It’s just not a significant part of our business it is not in our long-term strategy to really grow it much more we have so many sizes that we have to manage, we have the fits and now that we have the perfect fit, we have four different sizes within our suits to fit a guy who may be short and stout, or a guy who’s tall and lean, an athletic fit so we don’t see that as a growth business we have been in it for several years, but it’s just not significant to our future.

And last question here in terms of marketing and TV advertising, what should we be expecting for the holiday season versus last year and how does that fit into the entire mix going forward?

It’s our spend in the fourth quarter is very similar to last fourth quarter except we don’t have the incremental costs of a new commercial, we’re carrying a commercial that we’ve launched in spring, which has a much stronger impact than the commercial we ran a year ago we have increased our direct mail circulation, but all-in-all it’s pretty well apples-to-apples for us for the fourth quarter but again as we talk about targeting our customer, it’s much more focus and we did launch a catalog that got great reviews, our customers are referring to it, they’re coming in the stores they’re using it for mobile and as I mentioned before, I think that the catalog business which we abandoned several years ago we’re seeing a resurgence and a very targeted level we could be offering several season a few seasonal categories catalogs going forward.

It does look great. Good luck for the holiday season.

Great. Thanks a lot, Eric.

Thank you. And our next question comes from Chris Krueger with Lake Street Capital Markets. Your line is now open.

Hi good morning. You talked about your merchandise assortment improving can you tell us like your private DXL on private label brands versus the other brands like is it increasing as a percent of your total sales and can you give any examples of specific products that are working really well now versus maybe a year ago?

Well as we build out DXL and DXL’s comps outperform the comps of our other stores, there’s definitely a movement more towards more branded but it’s gradual, it’s manageable and we have not had an impact on our margins as one would suspect obviously because private label is so much, you get a higher margin but we’ve been able to offset that with great relationships with our brands normally we’re at the top of their list in terms of growth potential and we’re getting better terms with these brands, we’re getting more involved in the process of putting the lines together, it’s really been a collaborative effort so I think that the percentage of brands will continue to grow at a slow rate but again, we’ve been managing to go get through this over the years without really having any impact to the overall gross margins.

And you mentioned on the call that North Face has become a brand how long has that been in your stores and any other commentary on that?

Yes, we have a small cast late in the season to get some North Face product and, again, we’ve wanted for years we’ve been trying to get that brand and we really pulled it together and we put together a model for this year and candidly we were unprepared for the surge of sales we got right out of the box with the North Face so I think that we’re excited about having a great sell-through this year but on the other hand next year, we should be able to have a significant increase in their programs and again there are much more they’re very positive also in the success we’re having and we’re going to have a better a bigger and better assortment for next year.

And can you remind us last year in the Q4, did you have an extra week of business just a quick reminder on that?

Yes, we absolutely did last year the 53rd week, it contributed I want to I think it was about $7 million in sales and $1.5 million in EBITDA.

Okay. And finally any initial thoughts on store growth next year is that something we will wait for until a new CEO is in place?

Yes, I mean, again, I think we’re not looking at net store growth, but again, converting existing Casual Male stores into DXL stores is definitely growth potential for us we are getting nice increases when you think about it, this customer in this market has been seeing DXL commercials for 6, 7 years right now and wondering where’s their DXL store and even introducing it somewhat of a smaller it’s a smaller box we are getting a lot of new traffic and that just we had a perception of what Casual Male wasn’t really wasn’t connected to that brand and now they’re excited about getting DXL store in their neighborhood.

Alright. Thank you. That’s all I got.

Thank you.

[Operator Instructions] And our next question comes from Bernard Sosnick with Madison Global Partners. Your line is now open.

Good morning and congratulations on getting the follow through on your plans I’d like to talk about the CEO search one process and there’s another one who’s going to begin why will the second process do you think be more productive than the first?

Again, there’s no guarantees, but we’ve spent the last several weeks engaging with several different search firms and Russell Reynolds really created a dynamic thought process of the candidates they could bring in and for us it’s a refresh we have been at it several months and we’re just going to start with Russell Reynolds and we’re pretty excited and, again, we believe we’ll have somebody in place by the first quarter.

The other search firms I’m sure introduced you to some potential CEO candidates overall, what would you say were the factors that led you not to wish to engage them, were you’re not getting sufficient quality?

No, it wasn’t a matter there we are very practical I mean this is a big deal for us and we wanted to find the best candidate we possibly can and we just felt that it was time to move on and start with the new search firm it happens we’re not but it’s just a situation that came up and again, the search is starting now and that’s about all we can say and I would feel pretty good that we’re going to get a lot of fresh candidates.

I feel very comfortable that you’re going to be staying with the business seeing it through until the right time.

Absolutely, Bernie. I am totally committed and worked with the Board even though I am basically postponing my retirement. I am 100% committed, we’re on a great roll right now we have got some big initiatives ahead of us and I will do everything I can to continue to keep this the flow of this of our Company going until we get somebody in place.

I want to focus on ROI, you define that in your comments just now as improving the ROI on marketing now that undoubtedly is important improving the marketing and digital investment but the ROI overall is what we’re looking for and after what is it 6 years of losses, what is the probability of getting to an ROI that is minimally satisfactory in terms of overall return on investment?

Well, I think that, we’re always looking forward and we’re not at the point yet where we’re talking about 2019 but when we fully mature the expense savings we’ve laid out, because again, we only have 6 months of it we layer that in, we layer that in with the kind of comps that we’re looking for we are layering that in with the cost reductions, we’re having advertising as a percent of sales will start to come down we feel pretty good about the answer to your question, we feel pretty good that we’re getting there and hopefully when we on the next quarter, the call when we talk about 2019, I think you and the shareholders will be pleased that we’re definitely on the path to improve that ROI.

Well, thank you and best wishes, I guess we’ll be talking before your formal retirement but anyway best wishes to holiday season. Thanks.

Thank you very much, Bernard.

Thank you. Ladies and gentlemen, this does conclude today’s question-and-answer session. Thank you for participating in today’s conference. This does conclude today’s program and you may all disconnect. Everyone have a wonderful day.