Destination XL Group, Inc.
Q2 2018 Earnings Call Transcript

Published: 30 Aug 2018

[Operator:]

Good day ladies and gentlemen and welcome to the second quarter 2018 Destination XL Group Incorporated Earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. If anyone should require assistance during the conference, you may press star then zero on your touchtone telephone. I would now like to introduce your host for today’s conference, Tom Filandro, Managing Director at ICR. Please begin.

[Tom Filandro:]

Thank you, Norma, and good morning everyone. Thank you for joining us on Destination XL Group’s second 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?

[David Levin:]

Thank you Tom, and good morning everyone. This is our third consecutive quarter of solid momentum and progress in our business, highlighting in the press release this morning our sales momentum from the fourth quarter of last year has continued into the first half of fiscal 2018, and we registered another quarter of meaningful earnings improvement. We are successfully executing against our strategic initiatives and are well positioned for continued progress in the second half. This morning, I will briefly discuss our second quarter performance. I will then update you on our restructuring plans that we announced on our first quarter call, and finally I will provide insight into our strategic priorities before turning the call over to our CFO, Peter Stratton for a more detailed discussion of our financial performance. Now our Q2 performance. I’m pleased to report that we delivered our third consecutive quarter of positive comparable sales growth with a second quarter increase of 3.3%. The performance was slightly ahead of our expectations and was broad based across all channels and regions across the country. More importantly, we achieved the sales increase with 8.4% less inventory than we had last year and 15.2% less inventory than we had two years ago. Once again, our store associates executed on delivering outstanding in-store experiences with exceptional service, leveraging our unique selection and fit. Although in-store traffic remained slightly negative for the quarter, we did see a modest improvement from Q1. Where we did see strong performance was across key in-store comp metrics, including shopper conversion, transactions, and dollars per transaction signaling strong brand and product acceptance as well as store level execution. In our direct business, we continued to improve site usability and increased our shopper engagement through elevated storytelling, which has resulted in improved conversion, highlighted once again within our mobile platform. Our direct channel results in Q2 also reflected an improvement in our operating performance as we reduced our channel advertising spend and modified select promotional programs. We continue to look for opportunities to more effectively and efficiently operate our direct channel, and I’m pleased to report that we’ll be launching our enhanced website within the next few weeks. This new website will offer an easy and efficient shopping experience with less clutter and improved navigation so customers can quickly and easily find what they are looking for, especially within our mobile experience. We’ve also elevated our creative look and feel to better showcase the quality brands and products on the site. These improvements will allow us to engage more meaningfully with our current customers as well as bring in new customers to our franchise. In second quarter, on a trailing-12-month basis, our direct business penetration continued to expand, accounting for 21.2% of sales compared to 20.5% a year ago. We also continue to see very nice gains from marketplaces highlighted by Amazon, which nearly doubled in Q2 benefiting from a large portion of our assortment offered on Amazon Prime with two-day shipping. Similar to what we experienced in Q1, we continued 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 we are expanding the DXL market reach. Our gross margin was slightly ahead of our expectations and reflected a lower level of promotional activity in both stores and our direct business. One of our priorities is to become less promotional and more focused on our brand benefits, which include comfort, style, and fit. We’ve had more controlled online promotions and we’ve made some adjustments to our free shipping offers. One of the things I’m most excited about is the progress that we are making with our merchandise assortments. In the spring season, we had some great wins in our actives, denim, and young men’s assortments. The common thread among these three categories is the acceleration of our fashion assortments compared to our traditional basic offerings. Fall receipts have been coming in for the past two months and we are excited by some of the early reads that are emerging in our business. We’ve made significant improvements in shortening our lead times through our global sourcing team and now have the ability to react in season to fashion trends. With strong product acceptance and continued fine tuning of free shipping programs as well as changes to our shipping and warehousing strategies for our direct business, we remain confident our margins will continue to meet plan for the second half. Our adjusted Q2 EBITDA rose a strong 31% to $8.8 million in the second quarter from $6.7 million in last year’s second quarter. Our SG&A is well managed and benefited from our previously announced cross-restructuring plan. For the quarter, we registered $1.3 million reduction in SG&A expenses largely due to lower corporate overhead costs. We remain keenly focused on driving efficiencies in our cost structure across the entire organization. Overall, we had a strong quarter with a positive comp, a sequential improvement in margins and lowering spending resulting in solid adjusted EBITDA growth, and we remain confident the momentum will continue into the back half of fiscal 2018. Now I’ll shift to an update on our plan to improve profitability, which is anchored on four main strategic pillars, including

[Peter Stratton:]

Thank you David, and good morning everyone. I’d like to start this morning with a brief summary of our financial results. For the second quarter, net sales increased 0.9% to $122.2 million. The increase was due to a comparable sales increase of 3.3% and an increase of $2 million in non-comparable sales from DXL stores open less than 13 months. These increases were partially offset by closed stores of $2.3 million and $1.9 million shipped in calendar weeks due to the 53rd week in fiscal 2017. We were pleased to deliver our third consecutive quarter of positive comparable sales with growth in both our store and direct channels. Gross margin for the second quarter inclusive of occupancy costs was 46.3% as compared to a gross margin rate of 46.1% for the second quarter of fiscal 2017. The increase of 20 basis points was due to a 30 basis point decrease in occupancy costs as a percent of sales partially offset by a 10 basis point decrease in merchandise margins. The decrease in merchandise margin was related to an increase in shipping costs primarily in our direct business. Occupancy costs as a percentage of sales improved as a result of sales leverage as well as slightly lower occupancy dollars related to the closed stores. Our SG&A as a percentage of sales improved by 140 basis points for the second quarter to 39.1% as compared to 40.5% for the second quarter of fiscal 2017. On a dollar basis, our SG&A expense for the second quarter decreased by $1.3 million. The lower spend was due primarily to a decrease in corporate payroll and payroll-related costs related to our recently announced restructuring, as well a decrease in our marketing spend. These cost benefits were somewhat offset by higher expenses for ecommerce and technology initiatives. We manage SG&A expense through two primary cost centers, customer facing costs and corporate support costs. Customer facing costs, which include store payroll, marketing and other store operating costs, represented 24.3% of sales in the second quarter of fiscal 2018 as compared to 24.7% of sales in the second quarter 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 14.9% of sales in the second quarter of fiscal 2018 compared to 15.8% of sales in the second quarter of last year. We will continue to address our SG&A cost structure with an eye to improving our EBITDA margins and overall profitability. Let me spend a few moments on our corporate restructuring, which is designed to accelerate our path to profitability by aligning our expense structure with revenues. Since May, we have eliminated 56 positions or 15 of our corporate workforce. As a result in Q2, the company incurred $1.6 million for employee severance and one-time termination benefits. We expect to realize savings of approximately $5.6 million in SG&A expenses in fiscal 2018, and these savings have been factored into our guidance. On an annualized basis, we expect the restructuring to result in savings of approximately $10.3 million. The majority of the actions necessary to realize these savings were completed during the second quarter. Our adjusted EBITDA for the second quarter rose 31% to $8.8 million compared to $6.7 million in EBITDA for the second quarter of fiscal 2017. The improvement was driven by comp sales growth and a reduction in SG&A expenses due to lower corporate payroll-related costs as a result of the restructuring and the reduced marketing costs. Now let me turn to our balance sheet and cash flow. Cash flow from operations for the first six months of the year was $6.8 million. Our free cash flow was negative $600,000, down from positive $600,000 in the first six months of 2017. The decrease from 2017 is due to favorable working capital changes in inventory and tenant allowances in the prior year, mostly offset by our higher 2018 adjusted EBITDA and lower capex. Capital expenditures of $7.4 million were 46% lower than last year primarily due to fewer store openings, but we have had an increase in our IT capex due to the build-out of our new website and an ongoing project to upgrade our order management system and warehouse management system. Inventory at the end of the second quarter was down $9.4 million compared to last year and is down $18.4 million from two 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 as a percentage of total inventory is in good shape at 10%, consistent with last year and down on a unit basis. Total debt at quarter end was $61.2 million, which includes borrowings under the revolving credit facility of $46.4 million with excess availability of $41.3 million. This compares to $68.3 million of total debt a year ago and $43.7 million of excess availability. Despite the reduction in total debt, our availability has actually decreased slightly due to lower inventory levels, which affect our borrowing base. As we announced last quarter, in May the company entered into a new $140 million five-year secured credit facility with Bank of America. The credit facility includes a $125 million revolving loan facility and a $15 million first-in last-out term facility, both of which are at favorable interest rates compared to our prior borrowings. Our new revolver is priced at LIBOR plus 125 to 150, or an improvement of 25 basis points. The FILO facility, which was used to pay off our term loan with Wells Fargo, is priced at LIBOR plus 275 to 300, an improvement of 350 to 375 basis points. Overall, we expect that the favorable pricing under the new credit facility will save approximately $700,000 in interest expense on an annual basis. While we continue to pay down our debt, this extension provides us with secure access to funding for the next five years. Lastly, we are reaffirming our earnings guidance for fiscal 2018 which reflects the savings that we expect from the corporate restructuring. Our earnings guidance also continues to reflect severance and restructuring charges of approximately $1.8 million, of which $1.6 million was recorded in Q2, and approximately $4.2 million in costs associated with CEO transition expected to be incurred prior to the end of the year. Our reaffirmed guidance for fiscal 2018 is as follows

[Operator:]

[Operator instructions] Our first question comes from Bernard Sosnick of Madison Global. Your line is open.

[Bernard Sosnick:]

Good morning. Congratulations for a lot of progress.

[David Levin:]

Thanks Bernie.

[Bernard Sosnick:]

I’d like to ask about the end of rack customer - you didn’t speak about that specifically, you always did in the past. What does that represent in terms of sales?

[David Levin:]

When we started the end of the rack project, and for those who don’t know what that means, it’s really guys who are 42-inch waist to 46-inch waist, where before we started DXL, it was about 25% of our sales but about 60% of the market. Today, that number has done up dramatically - it’s closing in on 50% of our sales. In the high 40s are in that--actually, it’s about 45% are in that end of rack zone, so we’ve made a lot of progress on it, and now we’re just refining it further as we find a certain customer of ours who is really driven by fit and style. He does tend to fall into a little more of the middle of the rack than the end of the rack for us, but his buying power is dramatically stronger and we’re very excited about it. We also saw, and probably true of a lot of retailers, our top 5% of our customers represent almost 30% of our sales, and we’re really focusing in on our better customers because they’re easier to draw into multiple visits to our stores, and that’s really important to us because our average customer only shops us 2.2 times a year.

[Bernard Sosnick:]

Thank you, you anticipated my next question, which was the differentiation between the two, the fit customer and end of rack. Just in terms of detail, Peter, you mentioned $1.9 million regarding sales difference in the calendar shift. Was that a negative $1.9 million for the second quarter?

[Peter Stratton:]

Yes, so let me just clarify it. It really only has an effect on total sales increase quarter over quarter; and you’re right, the dollar shift that I mentioned was worth $1.9 million. Our comp sales are still being reported on comparable week, so the comp number is not impacted; however, it does affect total sales, so for Q2 we’re essentially adding a lower volume first week of August and eliminating a higher volume first week of May. Yes, it is a negative impact, but in Q3, it will have the opposite effect - we’ll be adding a higher volume first week of November and eliminating a lower volume first week of August.

[Bernard Sosnick:]

Okay. How much is that shift, do you think, in the third quarter?

[Peter Stratton:]

We haven’t identified that yet, but we’ll be announcing it on the third quarter call.

[Bernard Sosnick:]

All right. Thanks very much, appreciate it.

[David Levin:]

Thank you, Bernie.

[Operator:]

Thank you. Our next question comes from Chris Krueger of Lake Street Capital Markets. Your line is open.

[Chris Krueger:]

Good morning, nice quarter.

[David Levin:]

Good morning.

[Chris Krueger:]

Can you talk about your same store sales - were they pretty consistent throughout the quarter or did they start stronger or weaker? How did that go, and can you comment how they’ve gone in August so far?

[David Levin:]

We don’t give guidance for third quarter, but we did see within the quarter an acceleration as we moved through the quarter, and all we can say about Q3 is we’re optimistic. We feel pretty good about the way the business is trending right now. Traffic is definitely getting better.

[Chris Krueger:]

Okay, and then after you launch your new website, are there any extra marketing efforts or anything to try to accelerate your ecommerce business as you head into the fourth quarter and into next year?

[David Levin:]

Once we launch and it’s working well, we’ll be marketing the fact to our existing customers that we have--you know, it’s a brand-new website, it’s faster, it’s cleaner. We’re very excited about this. This has been in development for quite some time and it’s a real nice overhaul, and we know how important speed is, we know how important being clean and being able to click through as fast as you can, so--yes. The site will be up in a few weeks and we encourage everybody to go to the site. You’re going to see something that looks dramatically improved from where we were in the last several years.

[Chris Krueger:]

Okay. And then Peter, if I look at interest expense, it was a little bit higher than I had modeled. Looking out to the next couple of quarters, do you have a range we should probably try to keep that in?

[Peter Stratton:]

Yes, so the reason it looked a little bit higher this quarter, Chris, was because when we refinanced the credit facility, we had to write off some of the unamortized costs from the previous facility, so that charge all took place in Q2, but we’re still trending to that $3 million-ish number in interest expense for the year.

[Chris Krueger:]

Okay. Last, anything new on the competition front, any new guys emerging or going away?

[David Levin:]

Nothing that we’ve seen in the fiscal year so far.

[Chris Krueger:]

All right, that’s all I have. Thanks.

[David Levin:]

Thanks Chris.

[Operator:]

Thank you. Our next question comes from Bernard Sosnick of Madison Global Partners. Your line is open.

[Bernard Sosnick:]

Yes, thank you. With regard to the launch of the website, technology has improved and launching is less problematic than in the past, but at times, retailers have had difficulties during launches - re-launches, I should say. Do you have a contingency plan?

[Peter Stratton:]

Our contingency plan is we’ll operate off the old site, so until it’s really clear, it’s basically a hand-off, been tested and goes right to the new site, and if the new site isn’t up to expectations, we can continue to run on the old site. They’re running parallel.

[Bernard Sosnick:]

Okay, good. Thanks.

[Operator:]

Thank you. At this time, we have no further questions. I would like to turn the call back over to Mr. David Levin for closing comments.

[David Levin:]

Thank you all for joining us on the call. We’re getting quite excited here about the back half of the year. We think there’s great opportunities, so stay tuned and we’ll be talking to you on the next webcast with third quarter results. Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. You may disconnect. Have a wonderful day.