Destination XL Group Inc (DXLG) 2017 Q2 法說會逐字稿

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Good day, and welcome to the Destination XL Group Second Quarter 2017 Earnings Conference. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Tom Filandro, Managing Director at ICR. Please go ahead.

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Thank you, Kathy. Good morning, everyone. Thank you for joining us on Destination XL Group's Second Quarter Fiscal 2017 Earnings Call.

On our call today is David Levin, our President and Chief Executive Officer; Peter Stratton, our Senior Vice President and Chief Financial Officer. And also joining us today is Sahal Laher, our Chief Digital and Information Officer.

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

Today's discussion also contains certain forward-looking statements concerning the company's operations, performance and financial condition, including sales, profitability, EBITDA, gross margin, capital expenditures, earnings per share, free cash flow, store openings and closings, and the company's ability to execute on its strategic plan. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those assumptions mentioned today due to a variety of factors that affect the company. Information regarding risks and uncertainties is detailed in the company's filings with the Securities and Exchange Commission.

Now I would like to turn the call over to our President and CEO, David Levin. David?

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Thank you, Tom, and good morning, everyone.

I'd like to start off our call today with an update on where we are with the DXL transformation. As many of you know, we've spent the past 7 years here at DXL striving to create an unparalleled store experience with the XL community. Our DXL store format was designed to give bigger guys a place to shop that they would enjoy. We created a terrific store experience grounded in service, selection and fit. We now have 221 DXL stores covering every major market in the continental U.S. and have reached the point where our store rollout is now largely complete. We are now, more than ever, strategically focused on further building the DXL brand and aligning those efforts with the shopping behaviors of today's consumer.

To this end, we are elevating our marketing and digital development efforts on the second half of the year with a focus on creating and executing the right digital strategy that leverages and is fully integrated with our store strategy. We need to seamlessly provide our customers with the ability to shop with us anywhere, anytime and on any device. We must continue to innovate and evolve our position as the industry champion for the XL Community.

With that said, I'm very excited to announce that Jack Boyle, the President of Fanatics; and Oliver Walsh, former Chief Marketing Officer at Aritzia, have joined our board and bring significant experience and expertise in the areas of e-commerce and brand management. In addition, Oliver has agreed to serve at a temporary consulting basis as our Chief Marketing Officer while we conduct a search for a full-time CMO.

At the beginning of the year, we announced that Sahal Laher, former CIO of Brooks Brothers, joined our company as Chief Digital and Information Officer. In addition to Sahal leading our digital business, we are confident the first perspective and oversight of our e-commerce initiatives to new board members, Jack and Oliver, will provide a renewed sense of energy and expertise as we build an integrated DXL store and digital strategy.

Now I'd like to make just a few comments about business performance for the quarter. Our comps edged up slightly positive in Q2, which was the second sequential quarter of comp improvement. When we reported first quarter results back in May, we highlighted strong performance in April, coinciding with the reinstitution of our advertising campaign, which ran for 10 weeks for the spring season compared to 6 weeks last year, successfully driving our brand awareness. In fact, post the campaign, our aided brand awareness scores rose 4 percentage points from 34% to 38%. Although the traffic environment remain challenging, our team successfully drove improved shopper conversion and a higher average spend per guest. The results are a testament to DXL's differentiated assortment and experience supported by a sales organization that delivers unparalleled customer service.

As a reminder, back in March, we highlighted that our first strategic initiative to grow our customer base would be supported by increasing our 2017 marketing budget by approximately 40%, which included expanding our television campaign in the spring as well as resuming the campaign in the fall. In an effort to leverage our store fleet and expand our digital presence to a greater degree, we have made the decision to increase our marketing budget by additional roughly $4 million for the second half with the maturity of the incremental spend dedicated to broadening our efforts into social advertising. We will also launch a fall television advertising campaign which compares to having no TV ads last fall. Our back half marketing efforts will utilize new creative assets that tell the DXL story, highlighting our fit, selection, quality and value proposition as we remain focused on customer acquisition and retention.

Our return on investment for this incremental marketing spend will extend beyond fiscal 2017 as we expect to begin fiscal year of 2018 with a larger customer base as a result of this additional spend. With accelerated marketing and digital efforts planned for the balance of the year, we expect to deliver a low single-digit comp in the third quarter and a low to mid-single-digit comp in the fourth quarter. We are invigorating top line growth by extending our brand reach and driving new-to-file shoppers to the DXL men's apparel brand.

Another highlight for us during the second quarter is that we're making great progress with inventory management and merchandise assortment strategies. We have reduced our inventory by 7.4% over last year, and this is allowing us to be much more flexible with our receipt flow . For example, last week, we received a shipment of printed knit wovens, which had a tested online and achieved a sell-through rate of nearly 90%. Normally, we would be one and done on that test for the current season with no ability to reorder due to a 9-month lead time. With a logistical change in our sourcing division and more open-to-buy, we were able to read, react and reorder a bigger buy, and we'll have those knits available for sale in 45 days. We plan to refine and grow our read and react capabilities, allowing us to offer more trend right in seasoned goods. Another merchandising area worth highlighting is what we call, What's On Tap. What's On Tap showcases the hottest trends in fashion with the younger XL shopper. Although small, we have had tremendous

success in our young men's segment, which is currently the fastest growing part of our business.

Stretch everything, the stretch looks, camouflage and hoodies are all having great sell-throughs

and were reacting in season.

Now let me shift gears and talk a bit about market share. While we have seen a drop in our store traffic than last quarter, our reports show that we have not lost any market share. In fact, according to our most recent customer polls, it looks like we have gained market share. Our OpinionLab customer survey averages 6,000 customer responses a month. One of the questions we ask is, "Have you purchased any Big & Tall apparel from anyone else in the last 6 months?" There's actually been a double-digit drop in our customers purchasing from the competitor. And however, we are seeing growth in third-party marketplaces such as Amazon. Starting in Q3, we will be fulfilling directly to Amazon's Prime customers. In our test run during last year's fourth quarter, we showed significant increases in demand once we were in the Prime program. So again, there is a lot of progress happening at DXL right now, and we certainly -- we are seeing progress in digital engagement.

Now for more insight into our digital initiatives, I would like to call -- to turn over the call over to Chief Digital and Information Officer, Sahal Laher. Sahal?

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Thank you, David. Good morning, everyone.

On the digital front, we remain focused on 4 key areas. First, acquisition: Leveraging digital marketing and a reach in intuitive online experience to attract new customers to the DXL men's apparel brand. Second, retention: Driving customer loyalty through targeted engagement and building the store of one, with curated looks and experiences for our consumer. Third, fit and comfort: Delighting the customer with unique experiences that feature personalized fit and comfort as a competitive advantage. And fourth, marketplaces: Expanding the DXL men's apparel brand reach by leveraging strategic business relationships such as with Amazon.

We have made the first step in elevating our engagement in our core shopper with the successful launch of our mobile app in July. The app is designed with our customer in mind, as it allows him to engage with the DXL men's apparel brand in a simple, intuitive and frictionless way. The app automates elements of our loyalty program, including a mobile wallet of loyalty rewards. With more than 80% of our customer base enrolled in our loyalty program, which represents 90% of our transactions, providing them with instantaneous access to loyalty points when shopping either online or in-store is critical. In addition, the app provides the customer with high-speed, intuitive access to our entire assortment for easier shopping. It also provides several additional features and perks, including location-based special offers, instant product searches as well as in-store barcode scanning of merchandise.

We are pleased with the engagement that we have experienced with our app and look forward to adding new features such as geo-location, beacon-based capabilities to better streamline in-store shopping experience, which we believe will accelerate the adoption rate. Ultimately, we envision the DXL men's apparel app as a platform to engage with shoppers in a personalized manner while offering even convenience to shop our entire selection of brands and private-label merchandise. The shift towards mobile engagement across the retail industry is indisputable, and DXL is now very well positioned in the game. Looking ahead, we are in the process of improving our website and -- anchored on faster and fewer friction points, including fewer screens and clicks to ease the shopping experience. While the focus will be on delivering several of these enhancements prior to the critical holiday peak season, this will be an ongoing initiative. Our digital channels will continue to be upgraded and enhanced using best-in-class technology such as artificial intelligence and machine learning to fuel a rich and personalized experience.

With regards to customer retention, we firmly believe that creating curated digital experiences is the path to the future. We are working with a strategic business ally to elevate our CRM system to feature best-in-class dynamic segmentation capabilities. This platform will take the 360-view of the customer beyond an omnichannel repository of preferences and prior purchases, and will infuse third-party data and insights, including advanced predictive capabilities that anticipates how, when and where they are likely to shop. We will have the ability to engage our customers in more meaningful experiences that are tailored to their unique preferences and needs. This will fuel not only better customer engagement but also higher frequency interactions between DXL and our customers.

As we previously touched upon, we are not looking at digital simply as e-commerce. The in-store customer craves the same level of personalized service and engagement. With that in mind, we are bringing digital elements to all channels of customer interaction. The mobile app will be coupled with other innovative technologies to deliver an enhanced in-store engagement and personalization approach that will be robust and scalable. Across all our digital channels, we have a clear strategic initiative to leverage our unique positioning as the expert in sizing for our customer. Beginning this holiday season, we plan to deliver an interactive digital sizing guide in an effort to elevate confidence in size selection, which we see as a brand differentiator and loyalty driver.

Now let me briefly turn to marketplaces. Broadening our reach through marketplaces represents a key strategic initiative which continues to evolve. During the second quarter, we elevated our positioning with Amazon and now a large portion of our assortment is available on the site. Although currently small, our initial marketplace selling experience has been strong. Interestingly, the majority of transactions generated for marketplaces represent shoppers who have never shopped the DXL men's apparel brand. As David mentioned, we'll be launching product on Amazon Prime in Q3, and we will focus on growing this important channel of distribution.

Finally, our e-commerce sales penetration on a trailing 12-month period was 20.5% at the end of the second quarter compared to 19.4% at the end of last year's second quarter. With several digital initiatives underway, we are confident that we will experience a measurable lift in our digital channel growth. Our strategic road map of digital initiatives will continue to grow this channel over the foreseeable future.

I would now like to turn the call back to David.

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Thank you. Sahal. Now that you have insight into what Sahal and his team have been working out since he joined back in February, the time is right for us to leverage the team's work with elevated marketing across social and digital platform. Sahal and his team are moving fast, and we're thrilled to have him onboard and excited about the opportunities in digital. With that said, I'd now like to briefly reiterate our store strategy.

When we opened the call, I mentioned that we're substantially complete with the DXL store rollout. To date, we operate 221 DXL stores with the presence in every major market in the continent of the United States. We will open approximately 20 new stores in 2017, down from 30 last year. The opening pace will drop dramatically in fiscal 2018 as we are planning approximately 5 new DXL stores. This strategy is financially aligned with our goal of delivering strong free cash flow while continuing to expand the brand reach of DXL men's apparel.

As we go forward, we will manage our store base strategically to optimize sales, brand awareness, inventory management and e-commerce distribution. We plan to close approximately 19 Casual Male stores in 2017, and we'll grow total company square footage for the year by approximately 2.6%. Our Casual Male fleet remains healthy with 115 out of the 117 stores in operation generating positive free cash flow. We will end the year with our DXL men's apparel stores representing 80% of our retail square footage. One final point about Casual Male stores, we're testing a remodeled program. Our plan is to stay within the 4 walls of the Casual Male store, upgrade our visual presentation, reposition our signage to DXL and add some of our brighter brands to the assortment. This is a low-cost alternative for us to round out some of the Casual Male stores that are too small to justify a relocation to a new DXL store, but still capitalize on the investment we are making with the DXL brand.

With that, I will now pass the call over to our CFO, Peter Stratton, who will review our financial performance. Peter?

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Thank you, David, and good morning, everyone.

I'd like to start off today with a brief summary of our second quarter 2017 results. For the second quarter, net sales increased 2.8% to $121.1 million, inclusive of a total company positive comparable sales gain of 0.1%.

Gross margin for the second quarter, including occupancy costs was 46.1% compared with 46.5% for the second quarter of fiscal 2016. Our merchandise margins decreased by 10 basis points, which is primarily the result of more promotions related to our inventory productivity project, which I will update you on shortly. We also experienced a 30 basis point deleveraging in occupancy costs, which is an improvement over our first quarter when our gross margin deleveraged by 100 basis points. Overall, we experienced a net decline of 40 basis points in second quarter gross margin, but we also reduced our inventory by approximately $9 million compared to last year, which is great progress for the business.

Now turning to SG&A costs. As expected, our SG&A dollars increased year-over-year by approximately 6% and deleveraged as a rate to sales by 120 basis points to 40.5%. Both metrics were an improvement from the first quarter. Similar to Q1, our elevated investment in advertising was the contributing driver to the second quarter SG&A dollar increase. On a dollar basis, SG&A expense increased to $2.8 million from Q2 2016 and was primarily driven by a $1.1 million increase in advertising costs. The balance of the increase was related to store apparel and supporting costs associated with our existing store base.

GAAP net loss for the quarter was minus $3.7 million or a loss of $0.08 per share compared with net income of $0.2 million or breakeven per share a year ago. Net income on a non-GAAP basis, assuming a normalized tax rate of 40%, was a loss of $0.05 per share compared to breakeven in Q2 of fiscal 2016.

It's also important to note here that the company recorded a $1.7 million noncash impairment charge against certain store assets in the second quarter, which, on a non-GAAP basis, contributed a loss of $0.02 per share. Our EBITDA for the second quarter was $6.7 million compared to $8.5 million for the prior year quarter. This was primarily driven by higher planned marketing costs associated with our television advertising campaign, higher occupancy costs and slightly lower gross margin compared to last year.

Capital expenditures for the first 6 months of 2017 were flat with the first 6 months of 2016 at $13.8 million. However, our store openings are more front-loaded this year, which will result in a lower CapEx in the back half of the year.

Total debt at quarter end was $68.3 million compared to $63.6 million at the end of the second quarter last year and includes borrowings under the revolving credit facility of $53.4 million with excess availability of $43.7 million.

I'd now like to circle back to our inventory position, which we are very pleased to report, is down approximately $9 million or 7.4% from the second quarter of fiscal 2016. This inventory reduction is a direct result of continued inventory initiatives we began pursuing in 2016 to improve timing of receipts and weeks of supply on hand as well as previously identified opportunities within our merchandising, planning and allocation functions to improve our inventory efficiency.

Our store level inventories are down approximately 3% to last year and our warehouse inventory is down approximately 20%. Most of our savings, thus far, have been derived from improvements in receipt flow into our distribution center. Beyond our DC, we believe additional opportunities exist as we look to optimize our assortment.

We previously highlighted that we believe that our inventory productivity initiatives would drive $8 million to $12 million of inventory improvements in fiscal 2017. With our $9 million reduction, thus far, we have already surpassed the low end of the target range and now believe we can achieve $10 million to $14 million of inventory improvement this year. Our inventory composition is healthy and current with clearance merchandise representing only 7.5% of our total inventory at the end of the second quarter compared to 7.7% for the same period last year.

Now let me turn to our 2017 guidance which we are updating today. Total sales of $470 million to $480 million; a total company comparable sales increase of 1% to 4%; gross profit margin of 45.5% to 46%; and adjusted net loss of $0.14 to $0.21 per diluted share, assuming a normal tax benefit of approximately 40%; EBITDA in the range of $20 million to $25 million; capital expenditures of approximately $22 million before tenant allowance of $5 million with approximately $13.7 million invested in new DXL stores; and last, free cash flow in the range of $13 million to $18 million.

Lastly, before we open the call for questions, I'd like to update you on our capital allocation strategy, including our share buyback. Our Board of Directors previously authorized a stock buyback program for up to $12 million in fiscal 2017. The company is forecasting free cash flow of $13 million to $18 million for fiscal year 2017, and we intend to use that cash flow to both pay down debt and buy back shares. As of the end of the second quarter, the company has repurchased approximately 1.9 million shares for approximately $4.6 million or roughly 40% of the board authorization. We are also targeting a debt-to-EBITDA ratio of 2x to 2.5x at the end of the year. As we invest more dollars into a new and more aggressive marketing campaign, we will be using fewer dollars per share buyback. Maintaining sufficient excess availability under our credit facility is our top priority, and we will be monitoring our free cash flow carefully to balance debt paydown with shareholder return.

And with that, operator, we will open the call for questions.

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(Operator Instructions) And we'll take our first question from Eric Beder with FBR Capital Market.

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This is Bryan Caronia on for Eric. Congrats on some solid trends of improvement in the second quarter. So the first question we had is obviously, your guidance is signaling for a materially stronger top line trends in the second half of the year, materially brought on by the relaunch of your fall advertising campaign. But could you speak to anything that you saw that maybe was occurring over the course of the second quarter or first half period that gives you greater confidence in terms of consumer traction and the acceleration of trends into the second half of the year even independent of the acceleration in your marketing spend?

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Yes, I think what we're seeing is what we're hoping for. First off, the awareness growing from 34% to 38% was good. Most importantly, we're focused on our customer comp, which has exceeded our plan for the first half of the year. And then, where the real payoff that's come in is from the store operations themselves because average transaction is up, units per transaction is up, conversion is up. So where we would have seen traffic in the low, mid-single digits rather than to report a negative comp. Those triggers were able -- for us to get to flat. Now we think as we can get to somewhat flat comps -- I mean, flat traffic, our comps should go up in the mid-single digits. So we think we're in the right zone right now, and we're very excited about the marketing campaign. And also that lift we're going to get with that additional spend in the second half will assure us of coming in with a strong base of customers going into 2018. Customer has a lot of traction and has a lot of leg, so we anticipate that customers we're picking up this year will flow right into next year for us.

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Great. And I suppose dove tailing off of that, could you maybe give some, any insight, that you'd allow to give in terms of what product categories are even potentially sort of what areas along the brand spectrum and where you saw a -- potentially areas of strength? Obviously in the past, you've spoken highly about the opportunity about the end-of-rack customer?

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Yes. Well, specifically to that, we're very excited about what we're experiencing in our young men's classifications. Historically, we have struggled in that area, never getting a lot of traction. But within the last year, we're seeing tremendous gains there. Now admittedly, it's coming off a relatively low base, but as of this week, our inventory in young men's is up over 100% and our sales are also up over 100%. And most of that's due -- we're expanding this classification into more stores, it's selling in all our stores, we're ramping up for fall, and with the -- even a bigger program for next year, and that's part of What's On Tap, our ability to move quicker. But clearly, this end-of-the-rack positioning is paying off because it's young -- it tends to be younger, as we've driven our age down of our customer considerably. And now we're reaching into that -- even in younger market, where there's great opportunity. This is a customer who likes to shop, who definitely shops more than 2 times a year. He's looking for what's new, and we are delivering great product on a very timely basis now.

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Fantastic. And then if I could just shift over to sort of the margin outlook both for this year and going forward. It's been a number of quarters now where -- since you guys have, if I'm not mistaken, generated over any sort of year-over-year gross margin expansion. Obviously, it's a bit of a jaded question as it pertains to the comparable sales growth. But where do you sort of see that, both in the short term and longer term, sort of settling in? And then secondarily, when you look at your marketing spend, obviously, it's growing considerably versus last year. But going forward, do you think that on a dollar basis or on a sum of percentage basis this is where you'd expect marketing to -- and advertising costs to somewhat settle into?

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Sure. So I'll take the first half of that question. I think when we think of gross margin, it's really important to understand both the merchandise margin component and the occupancy cost component. The occupancy costs are causing gross margin to deleverage because our sales have been softer than expected. And if we get that low single-digit comp, then we should see leverage on our occupancy costs. Merchandise margin, though, is one element of the business that we're really pleased with. Our merchandise margins are holding up very well in the second quarter. We dropped only 10 basis points to last year. But on a year-to-date basis, we're actually flat to last year. So we've seen no erosion to date in merchandise margin, but we've reduced our inventory position by $9 million. So we expect to continue working on that inventory reduction and maintain our merchandise margin. We just need to get a little more leverage on the occupancy costs to get back to where we traditionally have been.

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Second part of the question, on the marketing spend. It looks like a big crease on -- a big increase on paper this year. But we have to remember that we pulled the TV marketing in the back half of last year, so replacing that makes it look a little more expanded but we're pretty comfortable with that. The fact that this year we're spending about 6% of our sales on marketing, we feel very strongly about that. Again, 6 out of 10 of our customers still do not have awareness from us. It's important that we grow that top line, we're going to grow that top line by getting more customers. And as I said before, it's not an inexpensive investment to get a new customer, but he is sticky, and he's loyal, and once we get him into our database, we could market him for several more years. So we are definitely going to be more aggressive in the short -- over the next few years in that marketing area because we've got to drive more customers into our stores.

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(Operator Instructions) And we'll take our next question from Glenn Krevlin with GHC Capital.

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I had a couple of questions. One, the Casual Male old stores, the remodeled, retouch-ups, refurbished, whatever you want to call them, have you tested any of this yet to see what kind of lift, if any, you get?

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Yes. We're actually in construction right now. We're looking at the end of September to be fully opened. It's a -- we're remodeling it while the store remains open. What I can tell you is that the -- our average investment in a DXL store is $400,000 to $500,000. And here, we're looking at doing it for about $150,000. And again, we're going to be doing it in the same space. We're going to bring in -- we're bringing new fixtures, some lighting. And at this low cost, we're going to find out the leverage of the DXL brand. I could tell you, historically, that the markets get very excited when they hear DXL's coming. So these are going to be in more remote areas where they probably haven't seen what a full-fledged DXL store has, but they have been seeing commercials for quite a few years about DXL, and we're going to be adding in a lot of the brands that were never available to them. We'll start with the more moderate price points, see what level it seeks and rebalance the assortments going forward. So with this -- again, it's in a test phase, we feel pretty good that it's going to be effective. And again, it won't be for all our DXL -- all our Casual Male stores. But the net, when you add it all up, we're at about 350 stores, and that number should probably stay in that area. We'll continue to edit stores where we -- where cash flow may diminish. But again, as I said, almost every single Casual Male store, 115 out of 117 are cash flow positive today. And their comps have been relatively okay after all these years of not investing any marketing money into the Casual Male brand.

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Okay. And then secondly, what are you seeing, David, on rent renewals? What kind of flexibility you think you'll be able to get now and maybe looking out the next couple of years?

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Oh, that project has been in place for a year now. We have virtually gone to every single one of our landlords. Whether we have a kick-out coming up or an option coming due or a longer-term lease, we are renegotiating all our properties with the landlords, and we've had very good success in rent reductions. We haven't quantified it on a dollar basis, but the project's ongoing, and I would say, we're winning almost everything with some concessions and some greater than others. But it's the right time for us to be doing this. With the issues of store closures, we're doing everything we can to keep all these stores profitable. So for rent reduction, we'll give it more life. We're going to fight for it.

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(Operator Instructions) We'll take our next one from [Bill Gordon] with [Gordon Capital].

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I guess this is a layup but I'm going to ask it anyway, to what extent is the Casual Male -- or are all customers available to buy online in terms of a simple brand? In other words, it seems to me the uniqueness of our customers should keep them in the store as opposed to try and buy something through Amazon or basically online. I just can't wrap my head around that threat. Is there such a threat?

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No. There's been a big movement into digital. I mean, it's now 20% of our sales are coming in through digital. And I think we have a good advantage on that because what we see for several years consistent right now is when our customers shop both our stores and online, their spend is 3 times on an annual basis from our customers shopping either digital or stores. So they're becoming seamless between each other. You can't -- you have to have them both working and whatever customers' strategy is for shopping at that time whether they want to be online or come in the stores, order online, pick up in stores. We have all those capabilities. And we see a great opportunity to expand our ability to gain market share. 350 stores is a lot of country and a lot of our customers are not accessible. We have some stores that are 200 miles apart from the next nearest store. These are great opportunities for us to hit the smaller communities. It's an opportunity for people who can't get out during the day. So honestly, we're very bullish about integrating our digital, making a smooth -- making it smooth between stores. And again, very excited, we brought in a lot of talent to really grow this part of the business and keep up with the technology. And again, the results have been very good.

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But I guess what I'm asking is, how easy is it for a large guy or chubby guy to actually buy online? Unless he knows that he's got a stock item, that you guys are next-door to him, that they tried your brand, they tried the size, they know it's different and, therefore, they can buy it readily, easily. But to return, the advantage obviously -- what's-his-name has this morning the report in The Journal, American Eagle, 70% of their business is coming from the local store -- from their local store, if you have a local store and you can have it return the product, and so that's good. And I recognize your returns are very low. But I guess what I'm asking you is, can people who've never visited your store actually buy online these unique items?

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Yes. And part of Sahal's presentation, he's talking about that we're adding a unique function that's going to tremendously improve getting the size right the first time. But this is really a critical point to make because in the regular size business or our competitors' business, if you're a size 2 XL, for example, every company has a different spec for this. Our global sourcing company does the tech text for every band that we have in our stores, so it allows us tremendous advantage because if our customer is a 2 XL, just trying it on once, he could go from brand to brand to our private-label brands, and he's going to get the same fit over and over again. And that is why our return rate is 8%, which is way below industry standards of apparel, which you hear returns are 25% to 35%. At 8% return rate, we could do this all day long, and we are not one of these retailers, who are saying, "Yes, our Internet is growing but it's impacting our profitability because the cost to do business is more." Not so in our case.

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And we'll go next to David Berman with Berman Capital.

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I was wondering if you could -- it's a tough environment out there, but I was wondering if you could just share with us a few things. First of all, I noticed that you bought back some shares or maybe the dilution. In this environment, and given that you do have net debt, I was wondering why you did that. I understand that stock's cheap, and I understand that -- but just in terms of focusing on the cash flow, we don't know what the future holds for us. Secondly, I want to know what your -- I see your days your inventory went down to 155, which is terrific, you reduced your inventories by about $10 million. And I want to know -- and still at 155 days, one doesn't know what it's supposed to be because obviously, if it's -- Men's Warehouse has got a much higher number but some of the apparel you guys have a much lower numbers. Where do you expect to be -- can you reduce that much more? And obviously from that, you're getting cash, right? So like, you've got $10 million extra in cash from that, which helped your cash per share -- net debt or your net debt that would help with that. And then the third question, it's interesting that -- if I'm reading this correctly, I haven't actually focused on this before, forgive me. You have 140 days of accounts payables. And if I'm reading that correctly, that's about 4 months of payables, and I'm -- it's just unusual for me to see that in apparel. And I was wondering if you can sort of expand on that.

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All right. Let me get to the buyback part. When we announced the buyback earlier on, again, we weren't prepared with the digital side of the investments that Sahal has put in, and really have the pipeline ready to take on the marketing. So as we saw the great technology taking place and all these things being put in place, we realized we had the opportunity now to call an audible and really move those dollars into marketing, where we'll set ourselves up in a much better position than earlier in the year when we thought buying back the stock at a low price was the right direction. So we are -- we identified it during quarter 2, and we've basically have not been -- we are not buying back stock at this point in time and putting those cash flow dollars more into the marketing to grow our business further. I think the inventory issue is, we turn very slowly, we carry a tremendous amount of sizes. Again, our top-selling pant has 55 size combinations, and we've really upgraded our algorithms to lower the stock that we need to carry. We don't need to be 100% in stock by size. And through a lot of hard work, we've gotten that inventory down, and we're not done. We're seeing great opportunities. We have a consultant in that's been helping us with the next phase of that. So as Peter said, we could be reducing our inventory by as much as $4 million -- $12 million -- $10 million to $14 million...

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$13 million. So our free cash flow this year, we expect to be $13 million to $18 million. So the -- for the -- let me also just address the accounts payable question. So when you look at our balance sheet, it's roughly 1/3 -- the accounts payable, accrued expenses and other liabilities are roughly 1/3 accounts payable, 1/3 accrueds and 1/3 deferred rents. So we think that, that's pretty consistent with where it has been and where it should be. But as David said, we're continually working down that inventory opportunity that we have, and we think that there's some great opportunity to further reduce our days of inventory.

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And there are currently no questions in the queue at this time. I would like to turn the call back over to David Levin. Please go ahead.

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Okay. Well, thank you all for being on the call. We do have a lot of exciting initiatives ahead of us in the back of the year. And we look forward to sharing some of those results with you on the next conference call. Thank you very much for joining us.

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And this does conclude today's call. Thank you for your participation. You may now disconnect.