Destination XL Group, Inc. (NASDAQ:DXLG) Q3 2022 Earnings Call Transcript

Destination XL Group, Inc. (NASDAQ:DXLG) Q3 2022 Earnings Call Transcript November 17, 2022

Destination XL Group, Inc. beats earnings expectations. Reported EPS is $0.16, expectations were $0.08.

Operator: Good day, ladies and gentlemen, and welcome to the Destination XL Group Incorporated, Third Quarter Fiscal 2022 Financial Results Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to Ms. Shelly Mokas, Vice President of Financial Reporting and SEC Compliance at DXL. Please go ahead, Shelly.

Shelly Mokas: Thank you, Latanya, and good morning, everyone. Thank you for joining us on Destination XL Group’s third quarter fiscal 2022 earnings call. On our call today is 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 and other expectations for fiscal 2022.

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’m grateful for the opportunity to speak with you today about DXL’s third quarter results, and our continued commitment to the transformational strategy we have been consistently working towards since 2019 and that is delivering our results. Since I joined the organization in 2019, the world and macroeconomic conditions have certainly shifted each and every year, but our defined strategy has not, and this has driven outcomes in the face of headwinds. We know who we are, we know what we do and we know who we do it for. And our commitment to the big and tall consumer is relentless. At DXL, big and tall is all we do, and our positioning is in direct contrast to other retailers.

The big and tall man has largely been ignored by the broader apparel industry. Few brands, fewer styles and sizing based on someone else’s definition of regular, limit him every time he tried to find clothing. While most retailers of men’s apparel offer some level of big and tall assortment to their customers, it is often a single rack or a small sub department for no other omnichannel retailer is at their top priority. At DXL, we trade on the belief that we offer superior fit, superior assortment and an experience to him, period. We believe this leads to a relationship with our customers that is built on respect, trust and belonging. We exist to provide the big and tall man with the freedom to choose his own style and to wear what he wants to wear.

Now let me begin with our specific performance around the third quarter. I’m pleased to report that we achieved a comparable store growth of 8.7% over last year and a gross margin rate of 50%. Coupled with selling, general and administrative expenses, which were in line with our expectations at 37.3% of sales, these factors delivered an adjusted EBITDA margin of 12.7% for the third quarter. In addition, during Q3, we continued to grow the active file and achieved the highest 12-month active file customer count in the Company’s history. These results are driven by numerous factors including the development of our omnichannel portfolio, our transformational brand positioning, our approach to promotions, our merchandise assortment and inventory management.

We are continuing to make investments in people, processes and technologies to drive growth. Before I get into the details of each element and, at the risk of being repetitive, I want to reiterate that each topic is driven by the framework of an aligned strategy and a relentless commitment to the big and tall consumer. As we begin to peel back our omnichannel approach, let’s start by talking about stores. Stores were the shining star in Q3 with a plus 10.1% sales comp versus 2021. Our brick-and-mortar stores account for approximately 70% of our revenue and represent a significant touch point with the integrated cross-channel customer journey and relationship building experience only available at DXL. Throughout Q3 and compared to our record 2021, stores delivered accretive monthly sales comp of plus 6.1% in August, plus 10.4% in September and plus 13.6% in October.

This positive growth trajectory accelerated further from our Q2 results and bodes well in terms of the impact for greater potential results in Q4 and despite the macroeconomic headwinds. When comparing to 2021 abnormal consumer behaviors associated with the countries reopening post-pandemic and the accompanying consumer revenge buying driven by both supply chain shortage fears and tentative demand, we believe this return to stores is even more impressive. Importantly, Q3 store performance was bolstered by an increase in dollars per transaction as well as markdown levels at an all-time low, two really important signs of health that I will revisit in the upcoming merchandise assortment and promotional approach topics. In the direct channel, across the browser, the app and marketplace, our direct and online business also showed growth versus 2021 Q3 at plus 5.5%.

The direct business comp sales growth was strongest in August and slowed down but remained positive in September and October as store growth accelerated. All three channels, the browser, the app and marketplace grew sales in the third quarter with the store integration to digital from universe sales the only declining element of direct. In terms of specific channel sales, the market place results led the pack. The continued growth of our marketplace business primarily on Amazon, but also on Walmart and Target Plus reduced our overall direct dollars for a transaction in contrast to the increases seen in stores. These dollars per transaction erosion is driven by the increased penetration of our big and tall essentials line on Amazon, which is targeted towards a different consumer than DXL’s core customer with lower price points.

We are continuously evaluating marketplace performance and product mix, knowing full well that consumer behavior shifts over the past few years have positioned marketplaces as shoppable search engines and points of discovery along overall customer journeys. Conversely, and as noted, we did not comp universe sales, but our belief is that with our materially better in-stock position in the stores, there is meaningfully less need to buy off the integrated web platform while shopping in our stores. Now shifting gears, I’d like to talk about marketing and, at a higher level, our continued and consistent brand repositioning. The brand’s repositioning is built around three key elements: why, how and what. Why we exist? We exist to provide the big and tall man with the freedom to choose his own style.

How we do this? Our go-to-market strategy, we relentlessly strive to serve the fit and style needs of the big and tall man. Big and tall is all we do. And of course, then what? What we do tactically, factually, pragmatically, we are a haven for the big and tall man with the largest assortment of brands and sizes accompanied by unrivaled expertise that creates an experience like no other. So by now you might be asking yourself, why should I believe this? What reasons could you — would you believe as proof points? Bear with me, if you will, there are five. First, industry-leading expertise on big and tell sizing, offering a fit that he can’t get anywhere else; second, the broadest and deepest assortment of big and tall national and owned brands, most of which are exclusive to DXL; third, the highest standard of construction and quality in our mix; fourth, a collection of brands and products that give him style options for most any occasion; fifth and finally, a level of service that gives them a better experience that he can get anywhere else, bar none.

We exist to provide the big and tall man with the freedom to choose his own style to wear what he wants to wear. Layer this on to our 2022 marketing initiatives that were first referenced way back in — during our Q4 ’21 earnings call, loyalty and the CDP platform, and it’s a powerful story and platform to continue to build upon. To refresh your memory, our new loyalty program, which was soft launched in October and is largely now in place as of week one November with a complete revamping of loyalty. It is a program that encourages and rewards deeper engagement with DXL beyond just shopping while simultaneously providing greater recognition for our top customers. And the customer data platform, CDP, as it is often referred to — this launch is now underway in earnest.

And when fully operational in Q1 2023, it will enable greater personalization and segmentation across all CRM touch points, while also unlocking further actionable insights to fuel new customer acquisition and inform targeting. As the single source of truth and a repository of many sources of customer behavior, the CDP platform will greatly enhance our current predictive modeling capabilities while simultaneously consolidating and optimizing our CRM tech stack. Let me give you an example of how that manifests in a more tactical level, in terms of our promotional approach and gross margin impacts. When I first joined DXL, the Company was mired, and I used that word purposely, mired in a cycle of using broadly available coupons and discounting as a primary method of communicating to customers and driving sales.

Not only did this limit margins and restrict profitability, it also took customers that DXL trades solely on price and promotion and not our unique fit our mostly exclusive assortment and an incredibly compelling experience. We have significantly shifted our promotional since those days, deploying promotions only when necessary to address customer file inventory opportunities, a stark contrast from the previous and essentially always on and heavy-handed promotional approach. In addition, we are constantly reexamining our promotional portfolio and testing, learning and often pulling back. Some examples of this occurred within our two-four programs and clearance strategies. During this year, we’ve seen a resurgence in interest and purchasing of dress wear items.

We revisited the constitution of our two-four program. As dress wear items like dress shirts, dress pants, ties and belts are often occasion-based and needs-based purchases we tested and ultimately remove them from our two-four promotional program. This also applied to underwear, which also qualifies within the need-based purchase category. The results has been a 4% increase in average order value without any erosion in unit demand and a pickup in margin directly associated with reduced promotional markdowns. Balancing a number of elements continues to be an opportunity, but hopefully, what I have shared with you gives you greater insight into our actions and pursuits. While our clearance Q3 penetration was up slightly in 2022 at 6.7% to 2021’s 6.4%, it is important to note that we have reduced our clearance discounting levels.

Last year’s deepest discount was 75% off, whereas this year’s deepest discount is at 40% off. This has served multiple purposes; one, further protecting margins and markdown rates; and two, allowing for the deployment of occasional additional percentage off clearance promotions to address inventory while also stimulating consumer demand. As we have been significantly less promotional than any prior year, we do understand that promotions may play a role within the marketing mix, especially in Q4 and during the holiday season. However, gone are the days of deep and broad promotions just for the sake of having a promotion, we now combine a multiyear disciplined testing and learning approach with a rigorous business, customer inventory monitoring and are consistently scenario planning to activate against near-term trends without creating long-term brand repositioning harm.

Building off of promotions and clearance discussions, I’d now like to talk about our merchandise assortment and inventory management. In terms of merchandise assortment and consumer trends, both contributed favorably to our Q3 business. The continued reemergence of dress wear and tailored clothing saw greater momentum and contributed 19% of our Q3 sales versus 15% in Q2, while also driving higher price points and more casual categories. In addition, we saw a strong performance in sportswear business with growth in sport shirts and casual bottoms and knits. And on the brand front, Harbor Bay is our bread and butter, which continues to headline our private label mix in driving sales and margins. In our design collections, we offer exclusive sales from Nautica, Vineyard Vines, Psycho Bunny and Robert Graham, each of which all drove year-on-year increases via fashion forward style assortments.

As I mentioned towards the start of the call, assortment is one of our key ownable differentiators. And in this regard, we are constantly examining our brand mix and opportunities to ensure that our big adult customer can truly choose his own style and wear what he wants to wear. And to that end, we are launching two new additional exclusive brands as part of our Spring 2023 reassortment. While I’m not at liberty to mention the names just yet, we are incredibly excited about bringing new exclusive additions, and we’ll be communicating additional details in the near future. Now inventory. Inventory on hand is another topic dominating the headlines in recent weeks. At DXL, we are measuring our inventory against 2019, which was the last normal cycle, not affected by the pandemic recovery and supply chain issues.

Compared to 2019, our inventory is down 11.1% with a 30% improvement in turnover rates. If we look more closely at the recent year-over-year comparison to Q3 2021, we have now right-sized our inventory levels and made up inventory, which is much more productive, ending Q3 at a healthy level at $106.8 million, which is a 30% increase to 2021. Shifting from the brand assortment and inventory discussion, I’d now like to talk about people, processes and technology, all of which apply to marketing. As you have seen from our recent press releases, in Q3, we shifted the structure of marketing leadership bringing or Jim Rees as Chief Marketing Officer; and John Sainsbury as Chief Digital and Analytics Officer. Both are leaders with extensive experience and proven track records in the brand — in the world of brand repositioning, go-to-market strategies, e-commerce and technical disciplines.

And their combined presence and expertise significantly bolster DXL’s capabilities. Building upon both Jim and John’s background and experience, we will continue to examine in marketing and technology processes, customer journeys, user experience and outputs with two fresh up device. While the results of the previous marketing leadership drove are commendable, especially navigating through the pandemic, Jim and John’s combined presence allowed DXL to shift even further from playing defense to playing offense with a focus towards the future, and as you’ve heard me reference before on previous calls. As I close out my comments, I’d like to address some macroeconomic factors and headwinds many of which are consistently appearing in today’s headlines.

As we know, 2021 was still a non-normalized year, which also included non-normalized behaviors, whether driven by pent-up demand from 2020’s off year, the issue of stimulus payments and supply chain outage fears impacting consumer shopping patterns. While many of these elements no longer impact 2022, we are very mindful of the new emerging impacts of the macroeconomic environment, and how this year’s factors, including recession fears, rising interest rates, inflation and consumer confidence translate to our business and inventory positions. Similar to how we manage through the pandemic, our actions will be informed, will be purposeful and will be decisive to navigate near-term realities without sacrificing long-term health. As an employer will tell you, labor continues to be a challenge in today’s climate.

Historically, DXL’s rate of open positions in stores hovered around 10%. Today, that rate is now closer to 14%, and we continue to place great emphasis on hiring back and looking to gradually improve this trend. We know that our employees are the face of DXL to our customers and our organization. And in that regard, my last remarks is in response to the entire team and to thank the entire team, acknowledging our employees and their commitment, their effort and the hours that they continue to tirelessly dedicate to DXL. This is a requirement on my part, not an option as they are what makes DXL, DXL, whether in the stores, in the distribution center, in our guest engagement center or in the corporate office, their commitment to DXL and our cause is beyond commendable.

I often talked about making DXL a true employer of choice and one factor in accomplishing this is our purpose-driven mission, which is DXL. The ability to truly make a difference and positively impact our customers’ lives is of a profound significance and unique in some ways to DXL. Each and every day, I’m extremely grateful to be surrounded by fellow employees that choose to believe in what we’re doing, that choose to believe in who we are doing it for and ultimately choosing to partner alongside DXL in that journey. I truly cannot thank them enough. And now, I’d like to turn the call over to Peter for an update on financials. Peter?

See also 15 Biggest Construction Companies in the World and 12 Most A.dvanced Countries in Biotechnology.

Peter Stratton: Thank you, Harvey, and good morning, everyone. I’d like to give you some more color around our Q3 financial performance, expectations for fourth quarter and our thoughts on capital allocation. Sales for the quarter were $129.7 million, up 6.7% from $121.5 million in the third quarter last year. On a comparable basis, adjusting for closed stores, sales grew by 8.7% with comparable store sales up 10.1% and our direct business up 5.5%. Compared to 2019, which was still our last normalized year, our comparable sales for third quarter were up 33.7%. The Compared to fiscal 2021, sales accelerated as we moved through the quarter with comparable growth of 7.4% in August, 8.5% in September and 10.3% in October. The continued resurgence of stores was the highlight of our Q3 sales and stores benefited from growth in traffic, conversion and dollars per transaction.

Our stores are in a much better inventory position today than they were a year ago with fresh merchandise and fewer out-of-stock positions. And our customer has benefited from that stronger assortment. The dollars per transaction have also risen as we have further reduced markdowns and seen deeper penetration in higher ticket categories like tailored clothing. Geographically, all regions outperformed their results last year, but the biggest gains continued to be in the Southeast. Sales trends in our direct channel were driven primarily by our dxl.com website and mobile app. And marketplaces continued to scale even faster than our core business. Partially offsetting these gains was a decline in our universe sales, which are sales that originate in the store but are fulfilled online.

This decline was tied to the better in-stock positions in the stores. As an omnichannel retailer, we remain ready, willing and able to meet the customer on their terms, wherever and whenever they choose to shop and we were pleased to again see growth in both the store and direct channels this quarter. As Harvey mentioned, there are many headwinds currently facing the U.S. economy, and we remain cautious but optimistic in our short-term outlook. We expect a single-digit sales growth increase in Q4, and that outlook is embedded in our guidance. Based on the strength of our Q3 performance and Q4 outlook, we are increasing our sales guidance from a range of $520 million to $540 million to a range of $535 million to $545 million. Let’s look at margin next.

Our gross margin rate, inclusive of occupancy costs, was 50% for the third quarter as compared to 50.2% a year ago. This 20 basis point decrease was the result of a 70 basis point decrease in merchandise margins, partially offset by a 50 basis point of improved occupancy leverage on the higher sales. The decline in merchandise margin was due to increased product and raw material costs, elevated inbound and outbound shipping costs and higher penetration of our marketplace business, which is burdened with third-party sell and commission charges. These factors were partially offset by the lower promotional markdowns that Harvey discussed. The magnitude of the year-over-year changes in shipping costs and markdowns has become less pronounced in the second half of the year than it was in the first half, and this should hold true for the fourth quarter as well.

For the year, we expect gross margins to be approximately 50 basis points higher than last year or approximately 50% of sales on the strength of our sales leverage and brand repositioning. Turning to selling, general and administrative expenses. SG&A expense was 37.3% of sales for the third quarter as compared to 34.5% of sales in third quarter 2021. As we’ve said before, our cost structure in 2021 was very lean and not sustainable to achieve our company’s 2022 sales goals and long-term growth. On a dollar basis, expenses increased by $6.4 million, which was primarily due to investments advertising to drive customer acquisition and engagement, store corporate payroll to support our sales growth and fill open roles, and an increase in performance-based incentive accruals.

Advertising for the quarter increased to 5.9% of sales, up from 4.5% last year as we seek to balance return on ad spend with customer file growth. Our full year advertising goal remains at 6.2% of sales, which provides us with the opportunity to further increase our investment in the fourth quarter. What this all means for the third quarter bottom line adjusted EBITDA of $16.4 million or 12.7% of sales and net income of $10.5 million or $0.16 per diluted share. The third quarter is historically challenging from a profit standpoint due to the seasonality of our business. So, we feel this is a strong result, and it marks our seventh consecutive quarter of double-digit EBITDA margins. Our business has transitioned from last year’s post pandemic surge to a more sustainable operating model that we believe will support long-term growth and market share and create value for our shareholders.

On the strength of our third quarter results, we are increasing our earnings guidance for the year to an adjusted EBITDA range of 12.5% to 13.5% of sales from our initial guidance of greater than 10%. I’d like to end with a brief discussion of cash flow and capital allocation. We ended Q3 with a cash balance of $23.5 million and no debt. Through the first nine months of 2022, we have generated $30.2 million of cash from operations. This was primarily the result of our adjusted EBITDA of $59.6 million, partially offset by inventory investments of $25 million to get us back to better in-stock positions in our stores. As a reminder, based on our historical net operating losses, we owe very little cash taxes on our earnings, so more of this cash is available to reinvest into the business.

We have invested $7.9 million of our cash flow into capital projects most of which has been in technology projects that support our stores, website and marketing and merchandising capabilities, all of which ultimately enhance our guest experience. For the full year, we expect CapEx to increase to $10 million to $12 million. We did not need to use our credit facility this year — this quarter, which had availability of $90.2 million and is in place until October 2026. Nor did we repurchase any more shares this quarter under our share repurchase program. As we look to future uses of capital allocation for DXL, I’m excited by the opportunities that lay before us, especially within our store portfolio. We have 283 stores today, of which 234 are DXL and 49 are casual male.

It has been a few years since we have undertaken any significant store expansion. And during that time, our footprint has slowly declined as we have edited down our portfolio to only our most productive stores. There are three concurrent paths we will pursue as we deploy some of our capital into stores in the future. First, there are pockets of the country where that are white space to us with no current DXL presence, but whose market demographics and our own analytics indicate strong support for a DXL store. We believe we could open up to 50 new stores over the next three to five years, and we are actively seeking real estate opportunities in such markets. Second, we will use this opportunity to finish uniting the store portfolio under the DXL banner by converting or relocating our remaining Casual Male anchor stores.

This is a proven and predictable model that has demonstrated a strong return on investment by capitalizing on the DXL brand. And third, we are reviewing our existing DXL portfolio to determine which stores might benefit from a remodel to introduce some of the more modern elements to the customer experience through updates to the layout, branding and assortment. We just recently launched the grand reopening of the first of these stores in Warwick, Rhode Island and the early feedback from customers has been tremendous. There are three elements to the Warwick model that I want to call out. First, we have opened up the exterior windows to provide a more appealing line of sight into the store, and we have changed the store signage from DXL men’s apparel to DXL Big & Tall.

Second, we have reset much of the interior to showcase lifestyle, fashion and exclusivity of brands in addition to creating digitally interactive guest engagement centers to enable a more consultative and integrated commerce opportunity and checkout experience. Lastly, we refreshed the visual merchandising to provide more focused support of brand identification and we have created a department for our Harbor Bay label, which now has a more clear identity than simply everyday value. It is still very early, and we will provide more updates on the remodels in the future, but we believe there is an opportunity to push this remodel out to many more stores in the future. The surge in our store business this year demonstrates that our customer still looks to stores to play a key role in their shopping journey and each of these store initiatives will help us to fulfill our mission of helping him to wear what he wants rather than his having to settle for whatever is available in a big box store.

I’m now going to turn it back over to Harvey for some closing thoughts. Harvey?

Harvey Kanter: Thanks Peter. Wrapping up today’s comments, I’d like to offer some additional perspective and closing thoughts. While we are proud of the results delivered in Q3, we are by no means complacent. DXL’s consistent and aligned strategy has not wavered, nor has our relentless focus on the big and tall customer. As we have reset our brand position, we have also reset our promotional cadence and strategy. Proposal planning and inventory management has ensured that we are well positioned for the holiday season. And while we create short-term impacts, we are simultaneously committed to long-term growth and making strategic investments in people, processes and technology that are all focused on delivering the immense opportunities you had ahead for DXL.

DXL’s transformation over the past four years is just beginning. We know the opportunity ahead is significant, and we are committed to growth and the teams who will get us there. And now, we will take your questions.

Q&A Session

Operator: And our first question will come from Mike Baker of D.A. Davidson. Your line is open.

Mike Baker: So, you gave a lot of good detail and metrics in terms of comp trends through the quarter, but wondering maybe more from a maybe more qualitative standpoint. Just your view on the consumer heading into the holidays, — there’s been a lot of different data points there suggesting some weakness, particularly in the first week of — starting after the first week of October. Again, you gave us plenty of metrics so we can see those. But just curious what — the way you’re thinking about the holidays, consumer spending, all those types of bigger picture macro ideas.

Harvey Kanter: Mike, I would say our answer is going to be no different than it’s been literally for the last two years. We believe we can push water uphill. I think our seventh quarter in a row of success, top line and bottom line, demonstrates that. The size of the file being the highest it’s ever been in the history of the Company demonstrates that. And the continued evolution of exclusivity of brands demonstrates that the wholesale community believes that we are the choice for big and tall expansion. I think the reality is, though, as we’ve always been conservative, our optimism is tainted, if you will, for lack of a better way to say, by the ongoing consumer elements, right, the recession, the elements of inflation, mortgage rates.

Those issues are not beyond us. And so while we believe we can push water uphill, we’re pretty conservative. And we believe that we will continue to grow this business. We are oriented around growth both short term and long term. But we’re definitely cognizant of the macroeconomic headwinds, and we have tempered that in our guidance. But even though we’ve taken it up, our guidance is from approximately to nearly 10. And so we’ve given a range of performance to acknowledge that there is the ongoing issue of volatility in the marketplace and obviously with the consumer.

Mike Baker: Okay. Fair enough. One more, if I could. Just looking ahead — maybe it’s too early to think about this, but looking ahead, to 2023 in the margins there. So, this year — so you had a huge margin last year. When this year began, you said, well, that’s not sustainable, and it could be around 10%. Now you’re clearly going to beat that I get why cycling the unsustainable pandemic margins made sense. But from here, from this new level, have we hit a new level where you can grow margins continually from the 12.5% to 13.5% level? Or are there one-time things this year that won’t repeat such that we might be down next year?

Harvey Kanter: So, at a very high level, I’m going to start this and then Peter will pick up. At a very high level, I think, the answer to the question has to be embedded in how we think about the business. First and foremost, we think about growth. And so Peter has alluded to a multiple number of expenses and capital utilization elements in terms of cash that we’ll think about that. And also in that context, it could affect EBITDA margins if we think there’s a greater opportunity to make investments and grow and invest in the business where the acceleration of EBITDA may not be as great next year because we believe that there are really material opportunities. To the degree those opportunities are not balanced well enough, we may not make those investments and of course, that will create an impact on margins.

So, I’m not giving you an answer specifically, but I think it’s embedded in how we think about growth and the investments we’ll make. And that’s a TBD based on how we come out of fourth quarter.