Destination XL Group, Inc. (NASDAQ:DXLG) Q3 2023 Earnings Call Transcript

Destination XL Group, Inc. (NASDAQ:DXLG) Q3 2023 Earnings Call Transcript November 17, 2023

Destination XL Group, Inc. misses on earnings expectations. Reported EPS is $0.06 EPS, expectations were $0.08.

Operator: Good day, and thank you for standing by. Welcome to Destination XL Group Incorporated’s Third Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Shelly Mokas, Vice President of Financial Reporting and SEC. Please go ahead.

Shelly Mokas: Thank you, Norma, and good morning, everyone. Thank you for joining us on Destination XL Group’s third quarter fiscal 2023 earnings call. On our call today are our President and Chief Executive Officer, Harvey Kanter; and our Chief Financial Officer, Peter Stratton. 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.dxl.com for an explanation and reconciliation of such measures. Today’s discussion also contains certain forward-looking statements concerning the company’s sales and earnings guidance, long-range strategic plan and other expectations for fiscal 2023.

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. I would now like to turn the call over to our CEO, Harvey Kanter. Harvey?

Harvey Kanter: Thank you, Shelly, and good morning, everyone. I appreciate the opportunity to speak with you all. For the agenda today, I’m going to give you a quick review of our third quarter results and then give you an update on some of our key initiatives. I’ll talk a bit about our expectations for the fourth quarter, and then touch on our evolving brand building and growth strategies that we see coming to life in 2024. At that point, I will turn it over to Peter for some more specific comments on our third quarter financial performance and an update on our outlook for the rest of the year. What I hope to accomplish on this call today with you is to simply share perspective; a perspective on where we are today, our strategy, our views on greater investment and what all of that means to 2024 and in turn, our expectations for achieving greater levels of growth for DXL over a period of time, which we loosely define as ’25 through ’27.

Our third quarter results missed our expectations and, like most other retailers, our business continues to be challenged by a difficult macro environment. We believe our customer has shifted away from the level of discretionary spending we experienced in 2021 and 2022 into more essential spending. We are competing for an ever-tightening wallet and economic headwinds persist. So, what exactly are we doing? To be very blunt, we are relentlessly focusing on controlling what we can control, where we can run a clean business and have confidence in our ability to operate and deliver against elements like merchandise margins, inventory levels, payroll and SG&A. Our challenge in Q3 was traffic, and that is job number one, driving traffic. But beyond this challenge, we believe we can execute our fundamentals at a very high level.

We can proactively manage our inventory to avoid overbought positions. We can monitor and adjust our coverage with store labor. We can resist the temptation to be hyper promotional and effectively buy unprofitable sales at lower margin rates. We have the ability to execute our store development plan. We have the ability to re-platform our e-commerce site. We have the ability to launch a new brand campaign that will drive share of voice, build greater awareness and generate trial. And we know, if consumers experience DXL, given our conversion, our repeat rates, lifetime value and our Net Promoter Score, we will win and grow market share over the next two to three years. And lastly, we can leverage our position as the authority on big and tall through collaborations with other iconic menswear brands as well as potential distribution alliances to expose DXL even greater.

Store development, the website re-platform, brand awareness, collaborations and distribution alliances are our major objectives over the next 12 months. I’ve said this before and I will say it again, with an addressable market of $23 billion, we believe DXL has the potential to scale far greater than where we are today. We are maintaining our focus on delivering an incredible assortment of both private brands and national brands that are designed with a superior fit and quality, all wrapped up in a modern-day retail experience, an experience that the big and tall consumer doesn’t get anywhere else. Supporting this is the DXL campaign, To Him and For Him. Our trademark, Wear What You Want, is an invitation to big and tall men across the United States to shop like everyone else by providing him the freedom to choose his own style.

The DXL campaign and brand positioning is part of its only further support my enthusiasm for our customers, our team and our mission, which is as strong today as it was when I first joined the company. If you can’t tell, I remain incredibly excited about our opportunities, and I look forward to sharing my perspective with you here today. One more quick note before I get into third quarter results. I want to share our perspective about how we view our performance. If you look at our performance on a straight year-over-year basis, our results have certainly been more challenging than in 2021 and 2022. There is no doubt we are facing a more difficult macro environment in 2023 than what we saw in the last couple of years. However, if you look at our performance against where we were in 2019, since we began DXL’s repositioning, it’s a very different point of deal.

Since 2019, we have driven comparable sales growth by more than 25%. Our adjusted EBITDA margin rate more than tripled in 2021 and remains more than double what it was in 2019 with our updated guidance. Fiscal 2023 is still forecast to be the third most successful year in the history of the company. Furthermore, very importantly, we have essentially recapitalized the balance sheet, and today, we are entering the fourth quarter with no debt, $60 million of cash and over $150 million of stockholder equity, which provides the greater opportunity to invest and drive our strategic initiatives. Despite the challenge in delivering another year-over-year of sequential growth, I think it’s important to recognize the results we’ve achieved and how far we’ve come since 2019.

But having said that, we still have much work to do. The slowdown in traffic that began earlier in the year intensified in the third quarter, especially in stores. We are seeing weaker sales in categories and brands that had a heightened level performance last year. For example, sport shirts and casual pants performed below our expectations, but both of these categories were exceptionally strong last year, primarily due to the continued resurgence of back-to-school and back-to-work and social events. Additionally, seasonally strong cold weather categories like outerwear and sweaters are off to a slow start. Despite coming in a bit short of our sales expectations in Q3, we continue to take steps to manage our inventory and mitigate inventory risk as part of our process, structure and discipline, while leveraging our supplier relationships and reducing our inventory receipt flow.

We also took advantage of clearance opportunities by using them to strategically create greater lower price point merchandise offers to address the challenged consumer, while also ensuring we avoid any buildup in unproductive inventory. As we progress through the year, our inventory position continues to improve. For the third quarter, our inventory is down 6.5% on last year and down nearly 17% to 2019. Our inventory turnover rate has improved from 1.3 times pre-pandemic to 2 times today on an annual basis. Clearance events have helped arrest overall softness in the web business, delivering healthy growth and new customer acquisition and increased engagement with our existing customer file. We see these events as an appropriate lever to lower the barrier to entry during economically challenging times, and we see no erosion in customer value during these events.

One area that we are incredibly excited about is our newest collaboration with UNTUCKit. While we are just over a month in, the initial results have far surpassed our expectations. The launch on October 12 was supported by a comprehensive marketing campaign on both DXL and UNTUCKit channels. We are selling shirt exclusively online, but we have also launched try-on capsules in 10 physical stores. We are monitoring the effects of traffic, engagement, and [new to file] (ph), and we expect these results will justify a more extensive rollout in 2024. This has been a big win for DXL, and we will continue to explore other strategic collaborations with other brands that are widely recognized due to their industry-leading marketing efforts, which will complement our curated assortment and will not cannibalize our established brands.

With each collaboration and truly meaningful brands already established, we believe this just builds on our already established leadership in the big and tall addressable market. Fit by DXL is not just a label, it’s not just a tagline, it is the very reason why brands not in the space are partnering with us. Our core competence in fit and merchandise planning, inventory management and the like is a core skill and an extensive SKU core count business that cannot be overstated. I also want to acknowledge the launches of Faherty and Hugo Boss. Faherty is exclusive to DXL and big and tall sizes and has been on the floor in 20 stores for the past seven weeks. Hugo Boss is delivering exclusive big and tall product capsules meaning in both examples, you cannot find this product anywhere else.

Boss, as it’s referred to, is available in 36 stores, and sales results for both of these iconic brands have surpassed our initial expectations. Excuse me. Both Faherty and Boss are fantastic additions to our assortment, will further drive the conceptual framework for our core consumer to wear what he wants, and given initial performance, we will be looking to expand the number of stores carrying this product in 2024. We’ve also seen great progress this past quarter with a number of our marketing initiatives. One of the topics that I talked about last quarter and want to update you on today is our e-mail platform, which continues to build momentum. Personalized behavior-driven e-mails have driven improvement in our click-through and open rates and further utilization of our new deployment platform remains a huge focus for the fourth quarter.

Digital conversion online has also increased for the first time in more than a year, driven by our robust e-mail program and continued healthy growth from our app. We are now just starting to anniversary the relaunch of our loyalty program, which was introduced last November. One of our biggest opportunities was to promote loyalty program benefits and educate our consumers and our members about the importance of participating. For example, unlike using a coupon, which often excludes designer brands, loyalty certificates are like currency and have no brand exclusions or purchase minimums. We’ve continued to evolve the positioning of the communication to lean into value as a material proposition of the program and better communicate the benefits in this regard given the economic macro elements.

We also wanted to closely align our Wear What You Want brand messaging with the loyalty tagline, Reward Your Style. Leaning into our designer brands to drive our positioning combines Wear What You Want with loyalty rewards to create greater value for the program and we believe this should drive greater engagement of gold and silver tier members and acquisition of bronze tier members as well. This is because our loyalty program is about how we treat our customers, our very best customers, in unique and engaging ways. We want the loyalty program to mean something special and provide something really different to our customers than just shop and save. I also want to touch on our Big and Tall Essentials, or BTE. This is a business that is designed to be sold through Amazon’s marketplace and has struggled to reach our expectations.

Back when we transitioned from Amazon’s private brand white label wholesale into DXL’s own Big and Tall Essentials, we believe there would be great potential for this product line. While we’ve been successful with our mainline private brand assortment on Amazon’s marketplace, our BTE line has been unprofitable due to ongoing shifts in Amazon’s model with increased advertising and fulfillment costs. We are significantly scaling back our BTE line in 2024 to focus on a handful of products that we can sell more profitably. We will still sell our mainline product brand assortment through Amazon Marketplace but with the exception of a few items, BTE is going to be phased out over the next year. I mentioned at the beginning of the call, I wanted to share with you our longer view and perspective.

We believe that we can change the growth trajectory of the company. And to do that, we need to expose our brand to new customers. We know that our awareness levels are far below, what we deem a reasonable and acceptable benchmark. We also believe that we can create greater awareness, then that leads to traffic and trial, and trial leads to repeat. And we believe this catalyst and that sequence can only be driven by effectively increasing our brand market. With regards to our brand building and awareness campaign, the process of identifying an agency partner to develop, build next campaign is well underway. We have an opportunity to create an irrational emotional connection with consumers within our Wear Want You Want ethos and drive brand awareness.

This is a shift from features and benefit positioning of the last several years. We are taking a strategic approach to identify creative agency that has deep retail experience and a track record of building emotionally relevant and compelling creative storytelling and will be a good cultural fit as an extension of DXL. We hope to select an agency by the end of the year, and our plan is to test the campaign as developed, produced and in market, in time for Father’s Day 2024. Concurrent with our creative agency search, we’ve also kicked off the early stages of media agency review to identify short-term needs related to upper brand funnel activity, media and mediums to accomplish greater brand awareness across marketing channels. Despite the current business landscape and the possibility of a prolonged economic challenge, we still believe this is the path to grow our business.

Fiscal 2024 is the correct timing to begin. We need to be bold and we need to go after this now and not wait until everyone is chasing the consumer with cash flush out of pockets and competitive advertising rates ever more expensive. That being said, we are evaluating the investment and magnitude of the plan in 2024 to ensure we are both pragmatic and thoughtful. We are targeting a campaign launch for late spring 2024, pre-Father’s Day, and we are prepared to conservatively spend on either 1% to 2% of sales to initially fund this initiative and, with positive results, we will fund this at greater levels over time, where we will read and we will react and determine further investment levels as the result and the landscape become clearer. Now, let me shift gears and talk a bit about stores.

I am very pleased to report on the September 30, we opened our first new DXL store since 2018 at Regal Park in Queens, New York. Queens was one of the last of the five New York City boroughs without a DXL store. We expect it will take a few years for this store to reach its full potential, but are very excited to be back opening new stores and Regal Park is pretty darn amazing. I’m also happy to report that our second DXL store will be opening in Cincinnati, Ohio in early December, and our third store will be opening in Pasadena in the Los Angeles market in January. We are aggressively working on a pipeline of real estate deals to continue opening DXL stores in 2024. And right now, we’re negotiating nine different deals for 2024 openings and hoping we can still yet find one more to bring the expectation up to 10 new DXL stores in 2024.

I’m also pleased to report that we have converted seven existing Casual Males stores to the DXL concept and three more are nearing completion now. That will give us 10 more stores converted to DXL by the end of the year and one more existing DXL store has been remodeled. Over the next three to five years, we believe we could potentially open 50 net new DXL stores across the country, which averaging 6,000 square feet, means 300,000 square feet in total new stores, square footage. I’d like to take a few minutes to address another topic that is one of the more frequently asked that we get these days. And that question is, to what extent do you believe the availability of new obesity — anti-obesity weight loss drugs could affect the company? Let me just start by saying that it’s not all uncommon for our customers to have their waist lines fluctuate.

What we’ve seen from many customers over many years is that when his weight fluctuates, it also necessitates augmenting or even fully replacing his wardrobe. It’s far too early to know what long-term impact these medications will have on the population, but we believe fluctuations in weight for whatever reason are a catalyst for buying new clothes. It has been widely reported that anti-obesity medications do not replace physical activity or healthy eating habits and the research that we read suggest that weight management programs work best when they are accompanied by healthy lifestyle change program, and I think that is one question yet to be answered. How many people will lose weight? How many people will keep their weight off if they go off on the vacation?

And for now, we look at it as a catalyst for our business. For now, this is an issue that we will continue to monitor. And with that, I’m going to turn it over to Peter for a few comments on the financials. Peter?

Peter Stratton: Thank you, Harvey, and good morning, everyone. On our last earnings call in August, we talked about how through six months, we were at a year-to-date sales comp of negative 0.5%. We further stated that we believe the third quarter will be a mid-single-digit negative comp and the fourth quarter could claw back close to flat. Unfortunately, that is not materializing as we expected. Total sales for the third quarter of 2023 decreased to $119.2 million from $129.7 million in the third quarter of 2022. Our actual sales comp for the third quarter was a bit lower than we expected at negative 6.7%. In August, we saw a sales comp decline of 6.5%. In September, we improved a bit to negative 5.4%. But in October, we fell back further to a negative comp of minus 8.3%.

Our direct business performed slightly better than stores at negative 3.2% for the quarter, while stores delivered a negative sales comp of negative 8.1% for the quarter. There is no question, but the greatest challenge we’ve seen this past quarter is declining traffic. Visits to our stores were down minus 5.9%, while dollars per transaction and conversion combined were down approximately 2%, with DPT being down greater than conversion. For the first three weeks of November, the business continued to perform at a mid to high single-digit negative comp. And given Q3’s volatility month-to-month, we are thinking the fourth quarter is likely a mid to high single-digit negative comp, and that is where our sales outlook remains for the balance of the year.

Next, a few comments about gross margin. Our gross margin rate, inclusive of occupancy costs, was 47.5% as compared to 50% in the third quarter of last year. The 250 basis point decrease was due to 110 basis point reduction in merchandise margin and 140 basis points in occupancy costs. The declining rate from occupancy costs was due to the deleveraging of sales and increased rents from lease extensions. The merchandise margin rate has been in-line with expectations and has held up relatively well in light of the economic challenges. We have remained low promotional with only a slight uptick in markdowns from the clearance events that Harvey mentioned and we have been able to offset increases in some of our private label merchandise costs with lower inbound freight.

Consistent with last quarter, we continue to see increased cost for fulfillment of direct-to-consumer orders and increased costs from our loyalty program. Both of these items were in line with our expectations. We are expecting gross margin rates for the year to be approximately 180 basis points lower than last year, down from our previous estimate of 100 basis points, primarily due to the deleverage of occupancy costs on lower sales expectations. Despite the deterioration we’ve seen in margin rate this year, we’re still pleased with the gross margin improvement since 2019. We expect gross margin for the full year will be approximately 500 basis points favorable to 2019. Turning to selling, general and administrative expenses. SG&A expense was 40.2% of sales for the third quarter as compared to 37.3% of sales in third quarter 2022.

On a dollar basis compared to last year, expenses decreased by $400,000 for the quarter and are down $800,000 year-to-date. As Harvey noted, we have worked hard to control the elements of our P&L that we can control and variable labor costs and discretionary spending, like travel are areas that we continue to keep a tight leash on. At the same time, we continue to invest in the people and technology needed to drive DXL’s growth strategy forward and investments in areas like store development and technology remain substantial. Advertising for the quarter increased to 6.3% of sales, up from 5.9% last year and focused primarily on paid search, direct mail and e-mail management that seeks to balance return on ad spend with new customer acquisition.

Our full year ad spend goal remains at 5.7% of sales and cost for the brand campaign won’t be incurred until next year. What this all means for the third quarter bottom-line is an adjusted EBITDA of $8.6 million or 7.3% of sales and net income of $4 million or $0.06 per diluted share. The third quarter is historically challenging from a profit standpoint due to the seasonality of our business, and we saw a return to more normal levels this year after two years of record-breaking third quarter results. Despite some challenges with the P&L, I am very pleased with the strength of our balance sheet and cash flows through the first nine months of the year. We ended Q3 with a cash and investment balance of over $60 million, have been debt free for two years and have full availability under our credit facility.

Inventory levels are down, we are turning faster than ever, and clearance remains under our goal of 10%. Thanks to our inventory management, we were able to increase year-to-date free cash flow to $22.7 million, up from $22.3 million a year ago, while also funding increased capital projects and eliminating our legacy pension liability. Capital expenditures year-to-date has been $10.4 million, of which $4.2 million relates to store development and the balance to technology and infrastructure projects. For the year, we expect our CapEx to be around $15.5 million to $17.5 million. Let me also provide a few comments on our share repurchase program. During the first nine months of 2023, we repurchased 3.1 million shares at an aggregate cost of $14.9 million.

As a reminder, the original share repurchase program approved by the Board of Directors last March, authorized a share repurchase of up to $15 million. I’m pleased to report that earlier this week, the existing program was amended to increase the maximum repurchase amount up to $25 million. The program expires on March 16, 2024. This new authorization provides the company with added flexibility to deploy capital for share repurchase when we believe the share price is compelling and will generate shareholder value. Despite the difficult macro environment, we are confident that our fortress balance sheet gives us this flexibility as well as provides the resources to weather an ongoing economic downturn while also funding our long-term growth initiatives.

I’ll end with our full year revised guidance. The economic pressures that have impacted consumer spending caused by — caused our third quarter sales to come in below our expectations and we have similarly revised our fourth quarter forecast. For fiscal 2023, we now expect sales to be approximately $520 million to $530 million, and our adjusted EBITDA margin to be between 10% and 11% on a 53-week basis. I’m now going to turn it back over to Harvey for some closing thoughts. Harvey?

Harvey Kanter: Thanks, Peter. I’d like to just close with a quick summary. But first, I want to say a sincere thank you to our team here at DXL. I feel as though our corporate culture is one of our superpowers and none of this would be possible without the hard work and dedication of our people in the stores, in the distribution center, in the corporate office and in the guest engagement center. Thank you for all your hard work and commitment in pursuit of serving big and tall men everywhere. And finally, I’ll offer you this closing perspective. We have authored a strategic plan. But in the current environment, the volatility of the consumer, the market, world events and the like, are quite challenging to achieving the magnitude of our goals in the timeline.

But march on, we must and we will. We remain relentlessly focused on executing our fundamentals and are committed to the strategy to grow and the initiatives we have spoken of today and often of in times past. We will open productive new stores, we will get the new platform deployed, we will launch a brand campaign, and we will keep pursuing merchandise collaborations and distribution alliances, taking more drastic actions such as offering deeper discounts and more broadly promoting and funding unproductive ROAS tactics would not make sense in the long run. We are not going to jeopardize the brand position that put so much emphasis and on over the last several years. Our trademark, Wear What You Want is grounded in fit, in assortment and experience and not in price and promotion.

We can’t control customer traffic, but we can control where we focus our effort and attention. We believe in the DXL brand and everything it can mean and we remain focused on the opportunity ahead as opposed to traffic struggles at this single moment in time. And with that, operator, we’ll now take questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Michael Baker with D.A. Davidson. Your line is now open.

Michael Baker: Okay. Great. Thanks, guys. You sort of addressed this in the prepared remarks, but I figured I’d follow up on it. Last quarter, spent a lot of time talking about a long-term investment strategy, which I think makes sense. Since then, it does seem like things have slowed. How does that impact your long-term plans, if at all I think, correct me if I’m wrong, but the advertising budget for next year is maybe a little bit more conservative than what you had talked about on the second quarter call? But just in general, what does this do to your long-term outlook, if anything?

Harvey Kanter: Yeah. Mike, it’s Harvey. I’ll address that at a very high level for competitive reasons. We don’t want to obviously share every element. But yes, the reality is it’s hard to understand where the customer is going and what the economic realities are over the next 12 months. So, we have moderated our investment view, marching forward with what we have planned because we think it is not just critical. It’s a critical imperative to do so if we’re going to gain share of voice and share of market. And we know that once we do that and get trial, we will win. But we are moderating that in the first half of the year to try to understand the return and the level of investment that makes sense and we’ll lean in even harder hopefully, as the economic realities become a little bit better in the second half of the year. But equally so, we have learnings in place to make sure that we understand what the return will be.

Michael Baker: Okay. That makes sense. A couple of others. One, interesting about the BTE pullback in Amazon. I get that it’s harder to be profitable there. But what about demand? And what does that tell you about your ability to go after — as I understood it, that was more of an entry-level type of product. What does that tell you about your ability to go after that customer?

Harvey Kanter: Yeah. There’s still — there really still is a meaningful opportunity to address the larger addressable market that is really outside the box, so I can better way to say DXL. The challenge with Amazon is actually not a lot dissimilar than Google these days where paid elements of search rise to the top and organic is much more difficult, and you have to buy that traffic. And if you don’t do that, you can’t get to the top. So, when the program was white label, the reality is that they owned it and they could drive it anywhere they want. When you think about the fact that we’re buying our way to search results and in addition to that, having FBA as part of our mix, the costs are just going up. And so, we’re trying to obviously navigate a fine line between the addressable market of the lower-income consumer and the profitability of that product, because buying product that then ultimately sells at a loss doesn’t make any sense.

So, it’s something that I would say is yet to be concluded. We believe there is greater opportunities. We continue to believe that over the long term, once we are at a point where we’re comfortable with the DXL brand and it’s well on its way, there are greater opportunities for a lower income consumer, whether that’s a new brand or new distribution channels or greater opportunities, we have had great learning by the BTE program and the top line versus the bottom line, which is distinctly different.

Michael Baker: Yeah. Okay. So yes, it sounds like it’s something that maybe you come back to in a different way. What’s more…

Harvey Kanter: Indeed.

Michael Baker: I don’t know if you can possibly answer this. But you’re right, there is a lot of focus on the GLP-1 drugs. And it makes sense to me that as weight lines fluctuate — waist lines fluctuate, that could actually be good for you. I guess, and again, maybe if you can, is there any evidence of that? Like would you even have any way to know which of your customers might be on that? And have you seen anything, understanding it’s very early in this whole situation?

Harvey Kanter: Yeah. In all honesty, we have been monitoring assertively, very assertively size penetration, and we haven’t seen any material shifts. But part of the reality is we look at our business in kind of three distinct ways. There’s the entry level, which is the rack of 38 to 40, so to speak. There’s core suite spot of our business, which is 43 to 46, and I’m talking about waist sizes. And then there’s the upper end of the rack, which let’s just say that 60 to 70. And in the range of our core suite spot, we’ve seen small movements, lower in scale, but in the core suite overall, it’s about the same. And so, it’s hard to really know where that’s coming from But what you might have expected is actually a greater level of move out of our middle core suite spot into sizes that are more competitive with other retailers and quite honestly, not our core suite spot, and we just haven’t seen that.