Destination XL Group Inc (DXLG) 2014 Q2 法說會逐字稿

Good day and welcome to the Destination XL Group second-quarter earnings call. Today's call is being recorded. At this time I would like to turn the conference over to Mr. Jeff Unger. Please go ahead, sir.

Thank you. Good morning, everyone. On our call today is David Levin, our President, Chief Executive Officer; and Peter Stratton, our Senior Vice President, Chief Financial Officer.

During today's call we will discuss some non-GAAP metrics to provide investors with useful information about our financial performance. Please refer to our earnings release which was filed this morning and is available on our website at investor.destinationxl.com, for an explanation and reconciliation of such measures.

Today's discussion also contains certain forward-looking statements concerning the Company's operations, performance, and financial conditions including sales, expenses, gross margins, capital expenditures, earnings per share, store openings and closings, and other matters. 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 risk and uncertainties are detailed in the Company's filings with the Securities and Exchange Commission.

I would like to now turn the call over to President and CEO, David Levin.

Thank you, Jeff, and good morning, everyone. Our results for the second quarter of fiscal 2014 are impressive particularly given the challenging retail environment this past quarter. Destination XL's strong results were driven by the continuing success of our DXL concept. In fact this quarter marks our fifth consecutive quarter of double-digit comparable sales increases for DXL stores.

What is particularly noteworthy is that the strong performance at our DXL stores was driven by increased traffic and higher conversion rates of store traffic. This shift is a strong indicator of success of our in-store marketing in our Casual Male XL stores to transition shoppers to the DXL stores. These are very important metrics to the long-term success of our strategy.

DXL stores sales for the second quarter almost doubled to $41.5 million compared with $21.5 million in the second quarter of fiscal 2013. Another very positive metric this quarter was our penetration of the end-of-the-rack consumer, those with waist sizes between 40 to 46 inches. Since the launch of our marketing program in Q2 of 2013 the DXL stores have grown the end-of-the-rack customers from 39.2% at the end of Q2 2013 to 42.2% for the DXL stores this quarter. We expect even greater growth in this consumer category as we more proactively communicate the sizes that we carry as we go forward.

There are two new metrics we have identified that are encouraging in the DXL strategy. First, in DXL stores that have comp, the average DXL store has 65% more customers in its active database than the average Casual Male XL store. Second, again in DXL stores that have been open greater than 13 months, DXL stores on average have maintained a 26% higher retention rate of customers than the average Casual Male XL store.

While we are working hard to redirect our Casual Male shoppers to the DXL stores, those Casual Male stores that remain open are also performing well. Customers that are not yet aware of the DXL stores continue to return to Casual Male XL stores to shop. Earlier this year we slowed the pace of our store closings and today Casual Male XL stores are serving as ambassadors to direct customers to the new DXL stores nearby by enticing them with coupons and other DXL marketing materials. As I mentioned, this is been a very successful strategy for us as we saw growth in our Q2 DXL traffic and conversion rates.

In the second quarter, our conversion rate of transferring Casual Male XL customers into DXL store increased 18% compared with the same quarter a year ago. As part of our marketing strategy, we significantly increased promotional offers to improve our conversion of existing Casual Male XL customers into DXL shoppers. Example promotions included a free Harbor Bay polo shirt followed by a gift card if they did not convert. We sent these customers an experience book to introduce the DXL concept and as a result one in three recipients visited DXL store and made a purchase. This had the highest response rate of any direct mail piece we have done in the past.

At the end of April, we launched our latest DXL marketing campaign on cable, network TV, radio, and digital mediums. You probably seen our You're Looking Good ad that showcases the in-store experience and depth of brands we offer. Our ad last year was about increasing DXL brand awareness. This year's ad is really about bringing customers into our stores to shop. And so far, it is working. In-store traffic is up 6.5%; transactions grew 13.1%; and our conversion rate increased 6.2%. Also our web traffic conversion improved by 8% in Q2 2014 compared to Q2 of 2013. In addition, traffic in our destinationxl.com website was up 9% compared to last year. Another positive metric was our conversion rate from our mobile visitors was up 67% compared to last year.

While the increased investments in these promotional marketing activities had a slight adverse effect on merchandise margins in the second quarter, it is clear that they are proving successful in terms of traffic, conversion, and sales growth. We believe these investments will ultimately translate into long-term profitable growth for a business.

This fall we will launch the next flight of our comprehensive marketing campaign. In an effort to align our media presence with our key selling weeks we will be moving our fall advertising closer to the peak holiday selling periods. Last year we launched our marketing campaign in late September and it ran until Thanksgiving week. This year, we will launch our initial advertising in mid-October. We will air additional television and radio commercials around Thanksgiving and through mid-December.

We know that our marketing strategy works. While running, it drives more traffic and transactions at our store and online. Therefore, with this shift of timing of our advertisings, our sales in the third quarter of fiscal 2014 could be lighter than the same period of 2013, but we would expect to more than make up for any loss in sales in Q3 and see stronger sales during the key holiday season of Q4.

In regard to the Casual Male XL business, last year when we decided to accelerate the Casual Male store closings, we also reduced some Casual Male XL store operating hours. During the first quarter of fiscal 2014, we returned to standardized operating hours for all Casual Male XL stores which has positively affected business at many locations. As a result, the 7.1 increased during the quarter for our Casual Male XL retail stores, outlets, and Rochester Clothing stores was primarily driven by the comparable sales increase for our Casual Male XL retail stores.

Turning to our direct business, we have begun to see a turning point in this piece of our business. During the first two months of the second quarter of fiscal 2013, the direct business still included sales from our catalogs which we stopped sending in May of 2013. This created a very difficult year-over-year comparison for the two months of the second quarter fiscal 2014. As a result, total US direct sales for the fiscal second quarter were up only slightly year after year. We expect these comps to continue to improve in the second half of the year when we are no longer comparing to 2013.

We want DXL to truly be the destination for our customers and have taken steps towards becoming a true omni channel retailer. During the quarter, we improved the functionality of our destinationxl.com website and increased the frequency of our digital display marketing and promotional efforts. Also, customers who shop online have the convenience of having their orders to a DXL store location near them for easy pickup at no cost and with no minimum purchase. By providing more convenience and cost-effective shopping options, we can significantly enhance our customer shopping experience at DXL and increase the likelihood that they will return.

We have mentioned in the past that are direct business with Sears Canada was having a negative impact on our direct sales. During the quarter, we notified Sears Canada of our intent to exit the business and began the process of an orderly wind down which we anticipate concluding in the fourth quarter of fiscal 2014.

Our DXL rollout strategy calls us to open approximately 40 DXL stores and close approximately the same number of Casual Male XL stores and Rochester stores in 2014. We are being more selective about the timing, locations, and size of the new store openings. Store openings will be weighted towards the first three quarters of the year. As of August 2, we had 113 DXL stores open for business across the United States.

We expect our overall DXL square footage at year-end fiscal 2014 to increase by about 34% from the end of fiscal 2013. And at the same time we are improving our sales per square foot. Last year, DXL sales per square foot were approximately $147. We project this to increase to $160 to $165 by the end of fiscal 2014 and that we could reach $220 a square foot in the longer term.

Our initiative that will help us achieve this goal is our plan to open a number of stores with a smaller footprint of 5000- to 6000-square-feet select markets. The smaller footprint DXL stores also increase our opportunity for continued store growth beyond original projected 220 to 250 stores. The economics of the smaller 5000 to 6000-square-foot store is similar to our DXL larger format. Smaller box allows us to penetrate markets where we previously thought we could not be profitable by leveraging improved sales per square foot, occupancy costs, build-out costs, and CapEx. Today we anticipate opening 50 additional 5000- to 6000-square-foot DXL stores in select smaller markets and also in larger markets where geographical considerations warrants an additional presence but not another full-size DXL store.

DXL strategy continues to prove successful, giving us confidence that we are on track to further increase our top line, improve profitability, generate cash flow, and grow sales per square foot and four-wall contribution.

With that, I went out turn the call over to Peter.

Thank you, David, and good morning, everyone. I will start by highlighting the Company's results for the second quarter of fiscal 2014, and then provide a preview of our full-year guidance for fiscal 2014 which we reaffirmed in our news release today.

David provided the high-level discussion of our sales for the quarter, so I will get right into the details. Our total comparable sales increase of 7% or $5.6 million included an increase in a retail business of 8.5% or $5.5 million. The retail increase, which in turn was driven by our 61 DXL comparable stores, had an increase of $2.4 million or 11.3%.

You are seeing an exciting shift in our DXL store metrics. In fiscal 2013, our comparable sales growth was primarily the result of an increase in dollars per transaction. This quarter, our store traffic, store conversion, and number of transactions are all up over last year. In fact, for Q2, dollars per transaction slightly decreased by 1.1% while the number of transactions increased by 13.1% and our conversion rate of store traffic into transactions increased 6.2% primarily as a result of our marketing and in-store promotional initiatives.

Comparable sales from our remaining Casual Male and Rochester stores increased 7.1% or $3.1 million. This increase was driven by our Casual Male XL retail stores which have been performing very well since we returned to standardized operating hours at the end of Q1. In our US direct business, as David mentioned, sales improved slightly with an increase of 0.5 of a percent. But we are optimistic about stronger near-term growth for this business based on our results in July and that we will no longer have to compare with any catalog sales.

Gross margin for the second quarter inclusive of occupancy cost was 45.7% compared to gross margin of 46.1% for the second quarter last year. The decrease of 40 basis points for Q2 of fiscal 2014 was the result of a decrease in merchandise margin of 120 basis points, partially offset by a decrease in occupancy cost of 80 basis points. The decrease in merchandise margin was due to an increase in our promotional activity which we began in Q1 to encourage our Casual Male XL customers to visit one of our DXL stores.

We continued with a similar promotional programs and customer acquisition initiatives during the second quarter. This approach is helping to transition our existing customer base to our DXL stores as evidenced by our increases in DXL store traffic and conversion.

On a dollar basis, occupancy cost for the second quarter of fiscal 2014 increased less than 1% compared with the prior year. As a percentage of sales, the 80 basis point improvement in occupancy cost is due to a decrease in lease termination cost as we slowed the pace of Casual Male XL store closures with many of the stores staying open through their natural lease term. We are closing approximately 60 fewer stores in 2014 versus 2013.

As a percentage of sales, SG&A expenses for the second quarter of fiscal 2014 decreased slightly to 43.6% compared with 43.9% for the second quarter of fiscal 2013. On a dollar basis, SG&A expenses increased by $2.2 million or 5% for the second quarter of 2014 compared with the prior year's second quarter. Increase over last year includes higher marketing cost of approximately $1.1 million and an increase in payroll related cost of $1.1 million due to the additional operating hours in our Casual Male stores. Pre-opening payroll, training, and other incremental cost to support the DXL store openings were $800,000 for the second quarter fiscal 2014 compared with $1.3 million for the prior-year second quarter.

Net loss for the second quarter was $4 million or a loss of $0.08 per diluted share compared with a net loss of $1.6 million or minus $0.03 per diluted share for the second quarter of fiscal 2013. On a non-GAAP basis, assuming a normalized tax rate for fiscal 2014, the net loss for the second quarter of fiscal 2014 was a loss of $0.05 per diluted share versus second quarter fiscal 2013 net loss of $0.03 cents per diluted share. As result, or as a reminder, as a result of the valuation allowance against our deferred tax assets, we are not recognizing any income tax benefit on our operating losses in fiscal 2014.

During the second quarter of fiscal 2014, we notified Sears Canada of our intent to exit our business with them and begin the process of an orderly wind down which we expect to complete by the end of fiscal 2014. As a frame of reference, Sears Canada represented less than 5% of our direct business in fiscal 2013.

Included in the net loss of the second quarter and first six months of fiscal 2014, is a loss from operations from our Sears Canada business of $1 million or a loss of $0.02 per diluted share and a loss of $1.1 million or a loss of $0.02 per diluted share, respectively. The loss includes a charge recorded in the second quarter of fiscal 2014 at approximately $800,000, primarily related to inventory reserves and sales return allowances.

Capital expenditures for the first six months of fiscal 2014 were $18.9 million compared with $21.1 million for the first six months of fiscal 2013. The $2.2 million decrease is primarily related to the number of store openings during the first six months of fiscal 2014. As of August 2, 2014, we have opened 14 DXL stores compared to 17 DXL stores at August 3, 2013. We expect to open approximately 40 DXL stores and close approximately the same number of Casual Male XL and Rochester Clothing stores in fiscal 2014. In addition, the average square footage of a new 2014 DXL store is slightly less than the prior year, which will have a favorable impact on build-out costs.

From a liquidity perspective, at August 2, 2014, we had $5.6 million in cash and cash equivalents. Total debt outstanding of $48.3 million and $71 million available under our credit facility. Our inventory levels at the end of the second quarter were up $8.1 million or 7.5%. However, on a unit basis inventory was down at approximately 1% compared with year-ago levels. The increase in our cost basis is due to us carrying a greater percentage of branded apparel for our DXL stores which have higher carrying costs. In addition, we are making a concerted effort this year to take early receipt of merchandise to ensure that we are in a strong in-stock inventory position prior to key selling seasons.

And now turning to our guidance, we are reaffirming full-year guidance for fiscal 2014 today. To reiterate, we expect total sales to be in the range of $413 million to $418 million; comparable store sales increase of between 13% to 15% for the 99 DXL stores that will have been opened at least 13 months at year-end; gross profit margin to range from 45.5% to 46.1%; SG&A cost to be approximately $176 million to $177.6 million; operating margin to be between negative to negative 2.8%; and we expect a net loss of $0.21 to $0.27 per diluted share or a loss of $0.12 to a loss of $0.16 per diluted share on a non-GAAP basis, assuming a normal tax benefit of approximately 40%.

Our net capital expenditures for fiscal 2014 are expected to be approximately $36.4 million after considering expected construction allowances contributed by our landlords on the new DXL sites. These expenditures will be spent largely on our planned opening of DXL stores as well as technology projects to continue to improve the e-commerce site and the in-store customer experience. Fiscal 2014 net capital spend of $36.4 million, net of tenant allowances, will be funded from equipment financing notes, our revolving credit facility, and EBITDA generated during the year.

Borrowings at the end of fiscal 2014 are expected to be in the range of $35 million to $40 million under the credit facility with equipment financings of approximately $20 million. We have adjusted our expected year-end borrowing levels to reflect our intention to take early receipt of spring merchandise at the end of the fiscal year to ensure that we are in a strong inventory position before the season. As a result, by the end of the year we now expect to have a total debt position of approximately $55 million to $60 million.

This concludes my remarks, and we will now take your questions.

(Operator Instructions) Mike Richardson, Sidoti.

Good morning and thank you for taking my call. Just a couple of quick questions. First, I want to clarify something that David said in his prepared remarks. I believe he said that sales in the third quarter might be a little bit lighter year over year due to a shift in timing of marketing. Were you referring to total sales, or sales for DXL stores, or just sales in the comp base? If you could clarify that I would appreciate it.

It is really on the DXL stores. We have a quarterly shift ending in October. We are forecasting lighter sales because we are starting the ad campaign almost three weeks later and that is going to fall into the fourth quarter. So, again, our total forecast doesn't change it is just a shift of a lighter third quarter and a stronger fourth quarter.

Okay. And then regarding the penetration rate for end-of-rack customers. Is there sort of a internal goal? How should we be thinking about that going forward? How high do you think you can get that?

Well, from a empirical point of view, 65% of big and tall guys are in that size range. And now we're up to 42%. And remember at Casual Male it was 25%. So we are clearly moving it in the right direction. But you know these are big numbers to move. So we anticipate moving one, two percentage points year over year. And it will take time. But if we ever got to 50%, that would be great.

Okay. And then this last one and then I will let someone else ask a question. The 50 additional DXL stores that you plan to open in the smaller markets, are those going to be offset by Casual Male closings? And sort of over what time frame should we be thinking about those openings happening?

Yes, it is still -- there were a lot of locations in smaller markets that we were going to really abandon because we could not make the numbers work, and rely on the customer to go visit us online. And now, that we see this 5000-square-foot store works economically, it is allowing us to fill in a lot of the stores that would have closed. But I think this falls pretty much into the same timeframe over the next several years that we could be -- now we could be at close to 300 stores as opposed to 220 to 250.

Great, thank you very much and continued success.

Thank you.

Jack Balos, Focus Research.

Regarding the Destination XL stores, what is the timetable for the stores to become profitable? Like does it take a year or two years? When do they go into the black? And by the black, I mean incorporating corporate overhead not the four-wall thing.

Sure. Well, for many of our stores by year two we are seeing nice profits from the Destination XL stores. You know typically the stores see a very big spike in growth in the year one of conversion and then after year one the growth starts to settle down a little bit. But by that second year we are seeing profitability in the stores.

So, the 99 stores that you had in fiscal 2013, do they as a group go into the black this year?

Yes.

I assume the 48 stores that you had prior year are going into the black.

Yes, you know there's going to be some that are doing better than others but for the most part, yes.

I see. So -- but as a total classification, all the Destination XL stores as a group are operating a loss right now?

No, they are not operating at a loss. Again, it is a store-by-store evaluation. But most of our stores, you know, they are coming out even in year one and they are doing well and they are profitable. But our target and what we're looking for is by two that we are seeing them turning a profit by year two.

This is David. In consideration, most of these stores start in the hole about $100,000 before even open the door in year one. And then when you look in year two, the stores are looking for comps in the neighborhood of close to 15%. So by year two to take that impact of the initial preopening expenses and put a 15% comp on it, these stores really should be profitable in year two.

Now, what does that mean in terms of the entire company going into the black?

Well, we have -- we are spending a lot of time with our marketing expenses right now and once we see that start to come down over time, that is going to improve our profitability as well.

Okay. So what year do you expect for the Company as a whole to be in the black?

Within the next two years.

Yes.

Two years. In other words 2015 or 2016?

Well, you know we don't give guidance out that far but just generally we anticipate going into the black certainly in 2016.

2016. Okay, thank you.

Laura Champine, Canaccord.

Thanks guys. So our question is on the shift in advertising. Did you mention, David, that you think sales, total sales could actually be down in Q3? And what drove the decision to make that timing shift?

Sales will not be down. We have been running the five quarters at double digits. We anticipate a very strong August and September and we will give some back in October. It is still going to be a very good number. But maybe not at the 12s to 15s that we are talking about. So we would get something higher than that.

What precipitated that was looking at last year's performance, we had a very big comp in October and we had a very bad December. We had spent all our marketing by November 15. So we figured balancing it out more, getting the biggest bang for our buck when the customers are coming out and shopping, to put some money into the December time period will give us a better overall performance for the fall season then just repeating what we did before. It was a lesson we learned that we should have pushed the marketing out a little further.

Got it. Thank you.

(Operator Instructions) Bernard Sosnick, Gilford Securities.

Good morning. You mentioned a strong August and September; could you give us a clue as to what you have been seeing so far in the month of August?

All I would say we see continued trends from the last four or five months where we have been very -- you know, we have been consistently getting those double digits. We haven't seen any indicators out there that is changing that. Again, we are not a back-to-school company. In fact where most -- a lot of specialty retailers, August is a strong month, it is actually our weakest month in the fall season. Our business really starts to pick up in September. But we feel very good about [September] because last September we had a fairly weak performance and we are trending much better this year.

Good. You are saying 13% to 15% same-store sales growth for the 99 DXL stores for the year. That would sort of imply a 20% gain in the fourth quarter.

No, it is not that high. I mean the 13% to 15%, yes. But it is a little lower than the 20%.

Bernie, one of the things to recognize is last year 25 stores of the 50 we opened, opened in Q4. We are going to get -- and we know that we get the biggest comp when they first anniversary. So in Q4, we got a lot of you know we got 25 DXL [stores] that are going to comp strongly which is going to give us that extra boost in the fourth quarter. That is not including the marketing factor. That is just the timing factor. So, it is not 20% but it is certainly fourth quarter we anticipate being our best quarter of the year.

Yes.

Okay. Could you repeat what the inventory increase was?

Certainly. So our inventory was $116 million at the end of the quarter.

Yes, I have it up 9.8% I think. I thought you said 7.5%?

No, let's see here. You know it is up, I would call it, that 7% to 8%. You know it is primarily in the increased penetration and branded product. Our units are actually down a little bit, but we are trying to be in a strong, better position prior to the start of the fall season.

Bernie, we took in a considerable amount of more inventory in July than we did a year ago. And it is mostly a timing issue.

Yes, I understand that. I just either my calculation is wrong, or, well, let's drop that. Could you reconcile the GAAP and non-GAAP full-year estimates providing the difference of roughly $0.11 to get to the non-GAAP number? I am sure it includes $0.02 from Canada and then tax benefits.

Yes, primarily it is the tax benefits of 40%. The $0.02 in Canada is the other piece of that as well, but you can calculate that by just taking 40% of the GAAP number for the tax component and then the $0.02 on Canada.

Okay. As far as the Casual Male stores, you have increased the hours, you have got the sales increase. Are they running at a smaller -- are they running at a loss, is it smaller loss? What was the comparison for Casual Male and Rochester stores for the quarter in terms of profitability?

We do not break it out by division.

But I think the best way to answer it is the sales for Casual Male without the extended hours probably would've been consistent with its trend which has been relatively flat to plus one or two. We are forecasting that same trend once we get past the incremental lift we are getting from the store hours right now. But the lift that we are getting is almost purely coming from those expanded store hours.

Okay. And you expect the lift to continue through the second half and into early 2015.

Yes, we should anticipate high single-digit comps in Casual Male stores through March 2015.

Okay. Very good, thank you.

Thank you.

(Operator Instructions) And at this time we have no further questions. I would like turn the conference back over to our speakers for any additional or closing remarks. However, we have just received another question if you would like to take it.

That is fine.

Mike Richardson, Sidoti.

Thanks, just squeeze one more in if I can. Am I correct in directionally thinking about your gross margin guidance that you are assuming that gross margin is going to be up in the back half of the year? And I guess my question is with trying to reactivate customers and convert the Casual Male customers to DXL stores and what not, how is that going to happen? Or what makes that happen?

Well, let me just -- I will speak to the guidance piece first. So the range of guidance that we have given on gross margin is that we would be between 45.5% to 46.1%. The majority of that range is below last year. So our promotional cadence that we have been seeing in the first half of the year where we're trying to drive more customers to the DXL stores and reactivate some of our direct customers that haven't shopped with us in a while, that is going to continue for the rest of this year. So as I said, the range is flat to slightly down. And we will see how the second half comes out.

And what was the second part of the question?

No, that was -- Peter answered the question. So that is perfect.

Okay, great.

Thank you.

Okay, if there is no other calls coming in we would like to thank you for joining us today, and again we look forward to a good third quarter and reporting to you later in the year. Thank you very much.

And that concludes today's conference call. We thank you for your participation.