Destination XL Group, Inc.
Q3 2020 Earnings Call Transcript

Published: 20 Nov 2020

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter 2020 Destination XL Group Earnings Call. At this time all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's call may be recorded. I will now hand the call over to me to Nitza McKee. Please go ahead.

[Nitza McKee:]

Thank you, Michelle, and good morning, everyone. Thank you for joining us on Destination XL Group's Third Quarter Fiscal 2020 Earnings Call. On our call today is our President and Chief Executive Officer, Harvey Kanter; and our Chief Financial Officer Peter Stratton.

[Harvey Kanter:]

Thank you, Nitza, and good morning, everyone. I hope you're all healthy, safe and well. I'm grateful for the opportunity to speak with you today about DXL and the progress we are making as we continue to navigate through the pandemic. For the past eight months, we have been pivoting and adjusting to withstand the unrelenting impact of the COVID-19 virus on all of us, and also on the economy as we strive to position DXL for the long-term recovery and for future growth. Most importantly, and before I begin any remarks in regards to our business, I want to make a few remarks in regards to our associates, and their tremendous level of commitment and sacrifice during these most challenging times. It has been nothing but quite remarkable. I have made mentioned before about the element that most often keeps me up at night and it's worth saying again, it is the team. As specifically, keeping the band together; that is the very foundation of a great business. We are so incredibly proud of our associates in our stores, and our guest center in our distribution center and in our corporate office. The COVID-19 impact has been incredibly challenging and despite the deep commitment we had to our team and the culture at DXL, based on trust, empowerment and innovation, the pandemic and in turn DXL has also impacted many of these very same folks and their livelihood.

[Peter Stratton:]

Thank you, Harvey, and good morning, everyone. I'd like to provide you with the summary of our third quarter financial results and then spend a few minutes highlighting some of the actions we have taken to protect the long-term viability of the company. We've started to see the results of those actions in our third quarter P&L, cash flow and balance sheet. This gives me confidence that we are making the right decisions to get DXL through this pandemic and to emerge from this crisis well-positioned to continue serving big and tall guys across the country. With that said, let me give you an update on our third quarter financial results. Harvey already provided a pretty comprehensive overview of our sales results, so I'm going to jump right into gross margin. Our gross margin rate inclusive of occupancy costs was 36.5% as compared to a gross margin rate of 41.1% for the third quarter of fiscal 2019. This 460-basis point decrease in rate was comprised of a 280-basis point decrease in merchandise margins, and a 180-basis point deleveraging in occupancy costs against the lower sales base; although down versus last year gross margin rate showed significant improvement over the second quarter. We made progress in markdowns by focusing on more targeted promotions and margin rates improved each month as the quarter progressed. Shipping costs continue to increase year-over-year due to growth in online sales and free shipping promotions. As I talked about this past quarter, our real estate team was successful in negotiating store rent abatements in deferrals from many of our landlords, which limited the deleveraging of our occupancy costs this quarter. But as Harvey mentioned, the efforts to right-size our store occupancy costs to our new sales levels are still underway and we believe we can further close this gap. Now, let me move on to selling general and administrative expenses. For the third quarter of fiscal 2020, SG&A expenses were $32.8 million or 38.5% of sales versus the prior year third quarter at $42.1 million or 39.5% of sales. This $9.3 million year-over-year decrease is the result of the steps we took earlier this year, including adjusting store hours and staffing models to account for our new customer traffic patterns, significantly reducing marketing costs especially through traditional non-digital channels, eliminating certain corporate positions and reducing services travel and any discretionary spending. We continue to assess and rationalize our entire SG&A cost structure. As Harvey mentioned at the start of the call, we initiated the corporate restructuring earlier this month, which we expect will save the company approximately $9.7 million annually. These were very difficult decisions, but we believe they were necessary to increase our financial flexibility and preserve our liquidity. During the third quarter, we recorded a $1.2 million non-cash gain primarily related to our decision to close two underperforming stores. Both of these stores have been underperforming for some time, and we have previously recorded an impairment charge on the right-of-use assets. In the third quarter, subsequent to the recognition of the impairment charges, we exercised our kickout rights to terminate the lease. The corresponding discharge of the remaining lease obligation creates a $1.1 million non-cash gain, which is classified on our Q3 P&L statement as a reduction to the previously recorded impairment charges. The other $100,000 of gain was recorded as a reduction in store occupancy costs. This is the first time that we've recorded a non-cash gain due to the discharge of a lease obligation on a previously impaired right-of-use asset. However, such kickout rights exist in many of our store lease agreements. As we look to the next several years ahead of us, we may continue to exercise these kickout clauses from time to time in situations where occupancy costs are misaligned with sales performance. We have approximately 52 stores with kickouts or natural expirations coming due in Fiscal 2021, 44 stores in Fiscal 2022 and the remaining 220 stores in Fiscal 2023 and beyond. Adjusted EBITDA was negative $1.7 million for the third quarter, compared to positive $1.7 million for the third quarter of Fiscal 2019. Net loss for the third quarter was relatively flat with last year at negative $7 million as compared to negative $7.2 million, both $0.14 per diluted share. Now, I'd like to move on to cash flow in the balance sheet. We have talked on last two earnings calls about some of the immediate steps we took at the outset of this pandemic including amending our credit facility to increase our borrowing base, decreasing our payroll, operating and capital costs to align with the expected decrease in revenues, canceling purchase orders, negotiating extended payment terms with our merchandise vendors and reaching agreements with our landlords to defer abate rent. I'm pleased to report that our third quarter results demonstrate the effectiveness of these steps. For the first nine months of fiscal 2020, our free cash flow was a use of $11.6 million, as compared to a use of $25.4 million for the first nine months of fiscal 2019. Due to the seasonality of our business and the build-up of inventory prior to the holiday selling season, it is typical for us to have a use of cash in Q3. However, we were able to significantly reduce that impact this year, by aligning our inventory purchases with expected sales levels, closely managing our expenses in vendor payment terms and limiting our capital spending to only that which was necessary for our immediate business needs. This is a meaningful accomplishment and outcome given the situation at hand. Our capital expenditures for the first nine months of fiscal 2020 were $2.9 million, as compared to $11 million for the same period last year. The spending was focused primarily on initiatives to drive growth in our direct-to-consumer business. We're pleased to report that we had a cash balance of $21.4 million at the end of the third quarter, a slight increase from the $20.4 million, which we ended second quarter. Our total debt, which is comprised of our revolving credit facility and FILO term loan, is $82.9 million. If we were to look at debt net of cash, our balance was $61.5 million at the end of the third quarter, as compared to $77.5 million a year ago. We have $13.5 million of excess availability under our revolving credit facility, in addition to our cash on hand. Circling back to inventory for a moment, our inventory balance decreased by $25.3 million in the third quarter to $94.9 million, as compared to $120.2 million a year ago; this decrease right sized our inventory position for our fourth quarter sales forecasts, and was accomplished primarily through the cancellation of orders earlier this year. We expect to end the year in a healthy inventory position with less merchandise than last year end. As we place our inventory buys for fiscal 2021, we will respond to business changes buying into categories that are trending upward and pulling back in categories that have slowed down. This will allow us to narrow our assortment, while continuing to manage clearance levels. Despite the challenges of the past few months, at the end of Q3, our clearance inventory levels were down $800,000 from a year ago, and comprise 11.8% of our total inventory, just shy of our long-term goal of 10%. That's an accomplishment of which we are proud, especially in light of the reduction in our total inventory balance. As we continue to navigate through this pandemic, we will maintain a conservative approach to financial planning with an assumption of slow improvement in sales trends in our stores, and a continued acceleration in our direct business. We believe that the steps we've taken this year to preserve liquidity and maintain our financial flexibility represent important and significant steps on our way to a recovery. Given what we know at this point in time, we believe our plan provides us with a path to navigate through the next 12 months. We look forward to the upcoming holiday shopping season and continue to serve our big and tall customers across all of our distribution channels. With that, I would like to turn it back over to Harvey for some closing thoughts.

[Harvey Kanter:]

Thanks, Peter. As we focus on the balance of 2020 and look to 2021, we are ever hopeful for the health of our nation and really, humanity, for that vaccine being talked about today to quickly take hold, and over time, we're even more hopeful for some return to normal. However, that is actually defined for the future. And now, I just wish you all Godspeed and a happy and safe Thanksgiving. Operator will now open it up to questions.

[Operator:]

Thank you. Our first question comes from Eric Beder of SCC Research. Your line is open.

[EricBeder:]

Good morning. Hi, I have a very near-term question. We've heard about Black Friday being not as important this year in terms of the actual day, trying to drive traffic early to get customers to shop before, or is about pandemic, or is about shipping. How are you responding to that in the near-term in terms of your flow of promotions, in terms of getting people into the stores a little bit earlier?

[HarveyKanter:]

Yes, we like everyone else, have tried to appreciate - probably the biggest single challenge is that folks might not be comfortable coming into the stores to shop, and combine that with the level of shipping that is happening in the world today and the recognition that there's going to be challenged. We have started earlier in some of the things we've done, such as our direct mail vehicle, which normally would have arrived in-home on the Monday or Tuesday before Thanksgiving, has already arrived in home as early as the 14th of the month. And I think as of yesterday, we are at 83% in-home already. The promotion itself in that mailer creates two things as well, one, till last year, some level of promotion prior to Thanksgiving, which we communicated, then an event for Black Friday, if you will, and then event after Black Friday. So we've given the consumer a much greater runway to understand our offers, and what's available to them when. That being said, and as we've talked about, our offers and mailers communicate different offers to different folks through segmentation. And ultimately, is not uber-promotional. It's certainly not more promotional than the last year, because we believe, and our experiences demonstrated most recently, that the customer coming into the store is coming in on their terms. And we don't believe so far, we've been able to demonstrate to ourselves, the ability to drive incremental traffic that is either incrementally profitable, and in some cases, profitable at all. So you won't see us, and my hope is the world around us, be as promotional as people might anticipate. But time will tell.

[EricBeder:]

On that vein, I've seen the return of some TV advertising, how does that fit into the overall DXL marketing universe?

[HarveyKanter:]

Yes, it's a great question. We believe that the digital marketing is our core marketing lever, if you will. And it gives us the greatest ability to interact with three core constituents, if you will, the current customer we have, the customer that's lapsed, and customers that either don't know us or haven't shopped with us before. And all of that is accomplished both digitally, whether it's digitally through email, digitally through display marketing, digitally through specific search, organic or paid. But in addition to that, certainly as consumers come back to looking to buy gifts, there is an opportunity for us to continue to drive down the path of looking to take share of market. And we are on TV more frequently. We started - I think our first TV was on the nights, we are predominantly in places that you would expect to see us around football and the NFL, we have some extensions into what I would call either syndicated or current live TV in the evenings drive times. But primarily, in places that are either target or active customer needs to be reminded that we're still here. And those are being done more frequently with an attempt to both create incremental reach an incremental reach and frequency, or TRPs as it's referred to, and our hope is that it will address the casualization element, as well. So if you remember prior-year ads and looked at this ad specifically, you will see a much stronger orientation around casual and much less, if really any, specifically referring to tailored clothing.

[EricBeder:]

Great. And final question; inventories. You've ramped up buy online pick up from store, you've ramped up ship from store. Both of those pieces in many respects allow you to be less aggressive in terms of inventory holdings. Should we be thinking that the new permanent - when the world somewhat normalizes, that the new permanent inventory levels should be lower? And what should we think about how they can be maximized going forward?

[HarveyKanter:]

Well, great question. There's two inherent elements for sure in there. One is the nature of the shopping behavior and the dynamics of how that shifting, and inherently, there's a shift out of tailor clothing with suits, sport coats, dress slacks, even dress shoes, those all turn meaningfully slower. So number one, we're investing less in categories that turn slower, so that should help create incremental turn in and of itself and everything else at the same. And then in addition to that, to your point, we're trying to balance the maximization of revenue and the opportunity that exists with, really, the challenges and risk-inherent in situations like COVID flare ups, and how fast the customer will come back to the stores and what have you. So we're being relatively conservative in placing receipts. But as you might appreciate, if you don't have goods, you're not going to create business. So we're not so conservative that we don't think we'll be able to drive the revenue, we are expecting a small improvement in turn. Most of our turn improvement would come out of the shift in consumer behavior, as opposed to not buying goods and trying to run lighter in total inventories.

[EricBeder:]

Right. Good luck for the holiday season.

[HarveyKanter:]

Thanks so much. Appreciate the support.

[Operator:]

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

[BernardSosnick:]

Thank you. Congratulations on manoeuvring and adjusting so well. What I'd like to do is get a little bit of coloration on sales in October, and so far in November.

[HarveyKanter:]

As you might imagine, and I think has been widely published, we actually had, what I would qualify, and I stress the word qualify, a good September. We measurably beat what we expected will happen in September. It caught us by surprise in a good way. And then, I would say equally so, October trailed off in an unexpected way, not materially from our expectations, but it wasn't as strong as September. And that started a little bit in the beginning of October, but definitely accelerated in the second half of October. The fires in the West definitely had an impact, the COVID flare ups we saw and then unfortunately, the last week of October with the election delays and, as referred to CNN watching non-stop; all of that conspired in the end of October and the first couple of weeks of November to be pretty tough. Interestingly enough, as I've heard a few others talk about, I would say within the last, I think, it's four days, a material change like a light switch. And we are hopeful that those days will allude to what is possible in as we move into Thanksgiving and Christmas. Because the magnitude of the change, it's not something that just like a light switch happens. I think it's really a function of the consumer volatility of the world we're living in today, with things like the election and fires and COVID. But anyways, the short answer of what you asked for is, October went backwards. We did never really got out of that negative downward trend, and it continued into early November. But as I've noted, we've seen a material - truly a material change as this week, as we get closer to Thanksgiving, more back towards the September period almost.

[BernardSosnick:]

Thank you. That's very helpful. The other question I have is on accrued expenses. They're up around $3 million versus a year ago. What is the composition of that?

[PeterStratton:]

Sure. So, the accrued expenses, you're right, last year, they were at about $25 million, this year about $28 million. I believe it has to do with - it might be some accruals around some of the restructuring that we did and some other long-term incentive accruals, I believe. I can get back to you on that. But it is up a couple of million dollars, which I believe is due to those two reasons.

[BernardSosnick:]

Well, I was wondering whether or not - where the adjustments and rentals show up. Because these would seem to be, in my mind, accrued liabilities for where there's been deferral of rental.

[PeterStratton:]

Yes, so you'll see those in the operating leases, which last year was $233 million, this year it's $196 million. So, all of the adjustments to the leases are coming through that operating lease line on our P&L - on our balance sheet.

[BernardSosnick:]

But, as you deferred rental payments during 2020, are some of these going to become due in 2021 as additional expense?

[PeterStratton:]

Well, they'll be due as additional cash. So that's been part of our cash management strategy, and part of the reason why we've been able to maintain such a robust cash balance is because we have not had to make those payments this year, but they are deferred to next year. So they remain as accrued liabilities, but we were able to preserve the cash this year.

[HarveyKanter:]

Bernie, in terms of deferral, just so we're clear, our deferrals run very distinctly different for every landlord. In some cases, the deferrals could have started to come back in the fourth quarter from the second quarter. They could have been in 2021. They could be through the entire lease. So there was never a one-size-fits all of deferrals, because we have so many unique one-off landlords, are very unique to each landlord's agreement and partnership.

[BernardSosnick:]

I understand that. The input you provided is very helpful. Let me ask this. Given where you are right now, in November, with the light switch having been turned on, assuming all things remain the same, what are the probabilities of you reaching your sales goals for the quarter?

[HarveyKanter:]

We feel really good about our expectations. We are - our miss in October was not material, it just - the biggest miss was the overachievement in September, and then going backwards the other way in October. But relative to what we expected, October was actually pretty close. The recovery in November, we always knew that the election has never been, quote unquote, a friend. And with the unfortunate dynamics happening right now around that, the first couple weeks have been challenging, but we're literally right now in the last four days ahead of the, quote unquote, expectation for the month. And the question will be what happens? And unfortunately, I can't predict that, but four days versus the first two weeks, it's like complete two different ends of a continuum.

[BernardSosnick:]

Interesting. And what are your targets with regard to the ability to generate cash flow in the fourth quarter?

[PeterStratton:]

Sure. We feel very good about our ability to generate cash flow, because it's our richest cash point of the year. We've been getting our stores ready, and our inventories in a good position, we're just waiting to see how aggressively customers come into the store and come onto our website in this all critically important holiday shopping season. So I would say, we feel very good about it.

[HarveyKanter:]

One of the things, Bernie, you might not have caught - I know I covered a lot of remarks, but it's remarkable, in some specific cases, some of our very best brands, our inventories literally are down 40% and 50%. And we're chasing them incredibly well. In some cases, we cancelled, in some cases they didn't produce. But in spite of that, we have been in some weeks flat on negative 40% and 50%, and as we chase and receive more goods, that obviously is a win. The other thing is between our inventory levels, which, no matter what, will be down versus last year, and the reduction of expense and the reduction of lease, with just a little bit of sales momentum and a little bit greater than expectation, we will create incredible leverage. And we really have concentrated on giving ourselves the greatest opportunity from an operating standpoint to right-size the business. And in a downward environment, we think we've right-sized it, so we feel great about that. But if there is upside to what we expected, that downsizing will pay back measurably in leverage.

[BernardSosnick:]

I indeed did catch the 50% down in inventories and flat sales. I was wondering, since you brought up that point, whether it changes your viewpoint on inventory structure overall?

[HarveyKanter:]

Well, our goal certainly is to narrow - and I think we've talked about this pretty publicly, literally our vendor base for 2021 has almost been cut in half. And Allison is our head merchant and Katie our leader of planning, the two of them have put their heads together and really narrowed in the assortment, really invested in the most meaningful parts of the mix. And our merchants have done a phenomenal job working with our really important brands, as you might imagine, Ralph Lauren, Vineyard Vines, Psycho Bunny, all the brands that we've continued to really drive into. And they have been great partners in helping us steer, so we do expect that between the curation of the mix, which is greater than it's ever been before, and the specific intent to try to turn faster, there is meaningful upside and yet we're balancing that risk appropriately.

[BernardSosnick:]

Okay. And one final question, if I may. Could you amplify a little bit on the Amazon relationship? I didn't catch all of the details in terms of the bumps along the way, but it seems as though the relationship has a lot of potential looking forward. What would you say about that?

[Harvey Kanter:]

Yes, I would concur completely. I mean, the reality is Amazon has been no different than us in some respect, and specifically trying to understand the customer and how fast they'll buy. In our case, the Amazon Essentials program initially had some challenge, no different than anybody else. It came back very strong, so strong that it created the highest level of out of stocks we've ever seen for the program. Those out of stocks, given the manufacturing supply chain logistics, vessels, and what have you - or we chase them hard. And as we've gotten back in stock, I would not say we're where we want to be at negative 30% in terms of out of stocks, but the business is trending measurably ahead of last year. And as those added stocks get reduced further and further, we think there's upside. Amazon, as we shared on our opening comments, felt so good about the business and the opportunities for the business. We have expanded that to the good thread line, which the good threads line is literally a second private brand within their private brands program. And I wouldn't go on to characterize how many private brands they have. But if you look at their business, there's not that many, it's a pretty narrow finite group of companies they work with to create their private brand program. And because we had two, and we have - we're getting behind one and we'll drive the second, I feel great about the opportunity. It - they are a great partner addressing a customer base that for us, is different from our core customer. And as a result, we believe in additive and not cannibalistic.

[Bernard Sosnick:]

Well, thank you very much. Keep up everything you've been doing in a tough environment.

[HarveyKanter:]

Thanks so much. Have a safe and healthy holiday.

[Operator:]

Our next question comes from Timothy Staples of Staples Asset Management. Your line is open.

[TimothyStaples:]

Well, gentlemen, considering the overall leverage of the company at the time the pandemic started, you've done a magnificent job of preserving liquidity. You've stayed at 12 months of liquidity. You have preserved optionality for shareholders. I want to congratulate you and frankly say that as a shareholder, I'm one of your biggest fans.

[HarveyKanter:]

Thank you.

[TimothyStaples:]

So that all set aside, you, I believe, had said at the previous conference call and what I would call a somewhat cryptic way of you can take me to task for using that terminology for it, about the notion of raising capital in ways I wasn't completely clear about. I don't believe that was mentioned here. I don't know if the queue is out yet; so I haven't read it. Can you talk about that, talk about the relationship with your lenders? Again, you said 12 months of liquidity. So that really hasn't changed from three months ago, which is good. Can you speak to the broad aspects of what I'm talking about here?

[PeterStratton:]

Sure. So I think when the pandemic first hit, this was one of our very first and highest priorities, was making sure that our - we were leveraging our credit facility to the highest extent possible, we did make some modifications to our credit facility back in the spring, and we really-- we feel like we've had a great relationship with our banks and our banks have been very supportive of the DXL throughout the pandemic. I don't think that there is much else that we are interested in pursuing right now in terms of any type of equity financing, to the point that we stated earlier that we do have a plan to get us through the next 12 months. And that's being driven by just really strong working capital management. So the ongoing sales that we're delivering, we've right-sized and restructured our expense space. And to Harvey's point, we're starting to see more operating leverage, which is a key point to getting through that. When you look at our balance sheet, which the queue will be out later today, you'll see that our debt position, net of cash has actually significantly downed from where it was a year ago. So we feel relatively good about the capital structure right now. And you know, the big thing that we continue to watch is sales. You know, we can control expenses and we can manage expenses. But we need to keep a close eye on sales and that's how we plan to get through the next 12 months.

[TimothyStaples:]

Thank you for the answer. I am excited as a shareholder about what you've talked about regarding the operating leverage in the business, should those sales come and containing the cash burn. One final question around that is, back in January before this horrible thing struck, COVID, insiders are buying stock in the open market as high as $1.15, $1.20, I believe. It has been very quiet and no man's land of neither insiders buying nor selling the stock in the open market, considering that operating leverage and considering that there's a vaccine and considering that you may very well have 12 months of liquidity, it would be wonderful to see that broad-based affirmation of management in your ability to potentially turn this thing around. Does that window open up a few days after the earnings release as is customary? Or is there something that frankly, has been going on which I understand you couldn't tell me, for months on end that precludes either buying or selling by insiders in the common stock of the company? Because I think you got a really great chance here of creating value.

[HarveyKanter:]

Yes, I think the reality is the window is not materially different. Quite honestly, we've had our heads down. And the greatest when we as employees will create is in keeping this business moving forward and creating our own future. And each one of us makes decisions differently. So I can't speak for anyone. I certainly was in the market before and buying and I expect that some of us will be again at some point in time. The other thing I wanted to circle back on your comment relative to optionality, if you will. I think that part of what we've done and communicated as you refer to cryptically, in terms of fundraising and what have you, has been nothing more to continue to create optionality, we have been very aggressive on making sure that decisions can be made in a timely way versus on a reactive way. And our greatest success is giving ourselves optionality and being agile. And we continue to do that in every part of what we're looking at. So in terms of any fundraiser or what have you, I wanted to be clear, it's all about optionality.

[TimothyStaples:]

Thank you. Congratulations, again. And we've seen a lot of very, very difficult things happening in the retail space and the fact that you guys are still in control of your destiny is a testament to your skill sets and the quality of this management team. Thank you.

[Harvey Kanter:]

Well, thank you very much. Operator, I think that's the end of the questioning today. I would just like to suggest everyone stay safe. Stay home, wear your mask, and hug your loved ones. And thank you very much. Have a wonderful Thanksgiving.

[Operator:]

Ladies and gentlemen, this does conclude the conference. You may now disconnect. Everyone, have a great day.