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spk29: Good day, and thank you for standing by. Welcome to the second quarter 2023 Destination XL group earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising you your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Shelley Mokas, Vice President of SEC Financial Reporting. Please proceed.
spk01: Thank you, Catherine, and good morning, everyone. Thank you for joining us on Destination XL Group's second quarter fiscal 2023 earnings call. On our call today are our President and Chief Executive Officer, Harvey Cantor, 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.dxhealth.com for an explanation and reconciliation of such measures. Today's discussion also contains certain forward-looking statements concerning the company's sales and earnings guidance, long-range strategic plan, and other expectations for fiscal 2023. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those assumptions mentioned today due to a variety of risks and 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 Cantor. Harvey?
spk19: Thank you, Shelley, and good morning, everyone. It's great to have this opportunity to speak with all of you today. Today's agenda for our prepared remarks is a little different than a historical practice. As always, I'm going to talk about our quarterly results and then share with you some of our thoughts and expectations for the second half of the year. But equally important, I want to start sharing with you some perspectives today on where DXL is heading and our vision for the next chapter in the DXL story. When I joined the company back in 2019, What attracted me most to the company was an incredible business model serving an underserved customer that had the potential to scale. Since late 2020, and despite the pandemic, we have made tremendous progress in building process, structure, and discipline, which provides the foundation to position the company for greater rates of growth. The results we achieved in fiscal 2021 and 2021 to illustrate that progress. Given 2023's macroeconomic challenges, the goal of sustained double-digit growth is eluding us, but we do believe it is still to come. Today, we are announcing our plan to meaningfully accelerate growth at DXL through three distinct pursuits, which I'll discuss later in the call. But let me be clear. clear about this. We believe greater growth is on the horizon. My comments in the latter part of the prepared remarks will give you a sense of how we are thinking about greater growth and begin to define our roadmap for the next three plus years. But before we talk about the future, let me get started with a quick review of the current quarter's results. On our last earnings call in May, we talked about how we expect our comp sale results for a full year to be approximately flat, and for the second quarter, we expected a low single-digit negative comp. In the second quarter, we did, in fact, post a low single-digit negative comp of minus 1.4% as we guided to. The trajectory of our comp performance improved slightly as the quarter progressed. In May, we saw comp sales decline 2.8%. In June, comp sales improved to a negative 1.7%, And in July, comp sales were positive at plus 1%. In stores, traffic was tepid and our dollars per transaction were down slightly, primarily due to fewer units per transaction and some level of the consumer trading down from national brands into our private brands. This resulted in a second quarter comp decrease of minus 1.4% for stores. And in the digital space, a comp sale decrease of minus 1.3%. with traffic to the website and app up slightly, while dollars per transaction were down slightly and conversion was roughly flat. Continuing with the second quarter, one of the very brightest areas for this quarter is inventory. We are turning our goods faster, and our Q2 inventory balance is down 9.5% versus last year and down 20.7% versus 2019. Our merchandising, planning, allocation, and global sourcing teams have worked proactively to manage receipt flow and strategically execute programs to prevent any bloating of our inventory and our balances. This did lead to a slight increase in markdown levels compared to last year, but we are in a very favorable inventory position as we head into fall with markdown levels that are still very near historical lows. Our clearance inventory at the end of Q2 2023 is 9.3% as compared to 6.9% at the end of Q2 and fiscal 22. We are very comfortable with our clearance inventory levels, which are still less than our target of 10%. From a merchandising perspective, our formal sportswear and tailored clothing categories such as sport coats, sport shirts, and casual bottoms performed well in Q2. Seasonal product categories such as shorts and swim underperformed our expectations. Sales in tailored clothing increased 4% to last year and made up 16% of the total sales penetration compared to 15% last year. As a reminder, our current merchandise assortment is a balance of private brands and national brands. And in Q2, we did experience a shift into our private brands, as I noted earlier, with approximately 15%, 55% of our sales driven by our own brands and 45% driven by national brands. As I mentioned on our last quarterly call, we have two more iconic brands that are set to launch with DXL. I'm very pleased to report that Faraday and Hugo Boss are both joining our portfolio brands this fall. Both brands will be available in selected stores and online. Verity is exclusive to DXL in big and tall sizes, while Hugo Boss is delivering exclusive big and tall product capsules, meaning in both examples, you cannot find this product anywhere else. Also, we are launching a third brand as a collaborative effort with another iconic retailer. In September, we will be launching Untuckit, fit by DXL, in partnership with Untuckit. This brand edition will be exclusively sold by DXL, but marketed jointly by both Untuckit and DXL. Driven by a reputation for fit and Untuckit's product and brand following, we believe this is going to be a wonderful strategic alliance and a big win for the big and tall man. These brand editions and collaborations give us great confidence that DXL brand is building a reputation with other great retail brands as the place to be if you want to make your brand available to big and tall consumers. It really is an exciting time for us at VXL, and we are 100% oriented around growing this business. Let me also now touch a bit on marketing and advertising. There are a number of foundational improvements that we have been working on this past year, and a few are worthy of highlighting today. One is email deployment. which is critical to get right. We continue to make good progress on our long-term goal of developing more sophisticated ways to approach segmentation and personalized communication with our customers, including using modern software platforms, such as our CDP. During the quarter, we launched an upgraded capability to deliver more relevant, personalized, and individual behavior-based email communication to our customers in near real time. Consumer engagement has been excellent and likewise an improvement in revenue. We look forward to extending these capabilities to additional areas of customer need. This is but one further step in our journey to personalize and derive more uniquely relevant marketing communication based on actual personal shopping behavior. Another example of foundational improvements is the user experience on our app and on our browser-based website. Enhancements on both platforms have been developed and executed to specifically drive increases in conversion and have largely been defined by consumers' actual online engagement. In our app, for example, we've improved the design of our product catalog and product detail pages to address specific points of customer drop-off. And on our site, We've made updates to our navigation to increase customer engagement with our most valuable content. Next is our loyalty program, which was revamped and introduced last November. The loyalty program continues to evolve to increase active engagement, building upon affinity, which is what we envisioned from the onset. The second quarter was really focused on framing loyalty messaging better and engaging the consumer in more meaningful ways. To do this, we stopped auto-enrollment and doubled down on communicating why they should want to be part of DXL's loyalty program. We did this because we saw meaningful differences in tier levels of loyalty program cohorts, and ultimately, it was about the utilization of the program, not absolute membership. Because the loyalty program is about how we treat our customers, our very best customers, in unique and engaging ways, We want the loyalty program to mean something special and provide something different to our customers than just shop and save. The elimination of auto-enrollment creates a slowdown in loyalty acquisition, but it will in time improve brand affinity, or so we believe, through self-enrollment and then greater engagement, which ultimately leads to greater advocacy. Now let me touch on the second half, which is off to a tough start. So far, through the first three weeks of the third quarter, our combined comp sales rate is down 6.5%. The themes of why business has been tough are the same we have identified already, traffic, ticket, and conversion. Despite the slow start to third quarter, we remain relentlessly focused on five critical areas, file, relevant personalization, traffic, brand awareness, and customer experience to engage and serve the big and tall consumer. We are deploying specific tactics in each of these areas to encourage greater visits and avoid customer lapses. Some of our initiatives include path to purchase, the rollout of greater behavioral-based email triggers, upper funnel print media in the holiday season, and a rebalancing of the paid media investment mix Our path to success is grounded in improved traffic levels and ultimately better customer acquisition and retention. We are poised to begin refocusing on the brand's awareness and DXL's unique, differentiated position to serve the big and tall consumer like no one else can. And that's really what I want to spend the remainder of my time to talk about with you today. But before I do that, I'm going to ask Peter to run through the second quarter financials and how we are thinking about guidance for the remainder of the year. After that update, I'll come back on and talk to you about the next steps. Peter?
spk13: Thank you, Harvey, and good morning, everyone. I won't rehash the comps that Harvey already spoke to and are available in the press release we filed this morning. However, I will note that net sales for the second quarter were $140 million as compared to $144.6 million in the second quarter of last year. Our sales in the second quarter were impacted by lower dollars per transaction because customers purchased fewer units and in some cases traded down to lower priced options, which we believe is a result of inflationary pressures impacting discretionary spending. The sequential improvement in sales as the quarter progressed was a result of improved traffic to our stores and growth in our mobile app and email marketing. Traffic, ticket, and conversion Our core KPIs we will continue to pursue as we look to drive results in the second half of the year. Moving on to gross margin, our gross margin rate inclusive of occupancy costs was 50.3% as compared to 52.1% in the second quarter of last year. This 180 basis point decrease was a combination of 110 basis points in merchandise margin and 70 basis points in occupancy costs, primarily due to the deleveraging of sales and increased rents from lease extensions. The margin rate decline from last year's record high levels was in line with our expectations. We have remained low promotional, choosing to emphasize our superior quality, fit, and experience rather than discount prices, and our margin rate remains significantly higher than our historical rate. However, on a year-over-year basis, margins decreased due to a combination of higher costs in three areas consistent with last quarter. First, we decided to absorb the cost increases on certain private label merchandise, especially those at an opening price point level, rather than passing these on to our customer through price increases. Second, costs related to the fulfillment of direct-to-consumer orders continue to be elevated. And third, The success of our new loyalty program means that there are more customers redeeming loyalty certificates for a discount on their purchase. These three factors were partially offset by lower inbound freight costs on receipts from overseas. Although each of these elements will persist at varying levels through the rest of the year, we expect them to moderate to the point where gross margin rates for the year should be approximately 100 basis points lower than last year. Turning next to selling general and administrative expenses, our SG&A expense as a percentage of sales decreased to 33.9% as compared to 34.2% in the prior year's second quarter. On a dollar basis, SG&A expense decreased by $2 million, allowing us to improve by 30 basis points despite the lower sales. The decrease was primarily from lower performance-based incentive accruals and marketing costs, partially offset by new positions added in the past year to support our long-term growth initiatives, including new store development. Our add to sales ratio decreased slightly to 5% from 5.4% in Q2 of last year. For the year, we still expect to spend about 5.7% of sales on advertising. And as you might expect, we are being very judicious with expense management but we remain committed to investing in the people and technology necessary to support our future growth plans. With gross margin at 50.3% and SG&A expense at 33.9%, this brings our adjusted EBITDA in at 16.4% or $22.9 million for the second quarter. Although lower than last year's 17.9%, We are pleased with this result of being able to deliver a mid-double digit adjusted EBITDA margin rate for Q2 in the current sales environment. I want to spend a minute on one unusual transaction that occurred this quarter and will have some limited impact later this year as well. We are taking advantage of a unique opportunity to strengthen our balance sheet and reduce P&L volatility. we are terminating our legacy pension plan, which was frozen over 20 years ago and has been on our radar for quite some time. Due to the current interest rate environment, the termination gap between our pension liability and our pension assets is at its lowest level in at least the last 10 years. During Q2, we made a cash contribution of $1.6 million to the plan, And we recognize a non-operating charge of $4.2 million to flow the previously unrealized loss through the P&L. As of July 29, 2023, approximately 78% of the pension obligation has been paid, with the remaining 22% expected to be paid in the fourth quarter. At that time, we'll recognize the remaining charge, which we are estimating at approximately $1.5 million, and proceed with finalizing the termination of the plan. Capitalizing on the current interest rate environment to eliminate this variable viability from our books is a prudent and opportunistic use of some of our excess cash, which will benefit our shareholders. Speaking of cash, the balance of our cash and short-term investments grew to $62.8 million as compared to $22.2 million a year ago, with no outstanding debt in either period and availability of $81.8 million under our revolving credit facility. This improvement was on the strength of our free cash flow, which we define as cash flow from operating activities, less capital expenditures, which was $21.6 million for the six months to date. We continue to keep our excess cash invested in short-term U.S. government treasury bills, which are earning interest at approximately 5%. We also use some of this free cash flow to repurchase our stock on the open market, Over the course of the quarter, we spent $10.8 million to repurchase 2.2 million shares at an average cost of $4.81 per share. At the end of the quarter, that left us with approximately $4.1 million of our board's original $15 million authorization, which we have already fully utilized in the first three weeks of the third quarter. At the moment, we do not have plans for further repurchase activity this year. Harvey is going to talk in a minute about our growth plans, and we are very happy to have this cash available and the financial flexibility to fund and execute those growth plans. Before I conclude with our outlook for the second half, I just want to spend a moment on income taxes since this is an area where our year-over-year results require adjustment for comparative purposes. Last year, our second quarter results reflected a tax benefit of 35.1 million, which included the release of 35.5 million, or 53 cents per share, in valuation allowance reserves. Now that those valuation allowances have been removed, we have returned to a more normal tax rate of approximately 26%. However, we are still able to utilize our remaining net operating loss carry-forwards to reduce our cash taxes, and as a result, we'll pay very little in federal or state cash income tax in fiscal 2023. As a reminder, we began the year with $78.9 million in federal net operating loss carry forwards. Finally, I'll close with an update on our financial outlook for fiscal 2023. which we are trimming today in response to the difficult macro environment and ongoing volatility we are expecting in the second half of the year. Our updated guidance is for net sales of 535 to 545 million in an adjusted EBITDA margin of approximately 11 to 12% on a 53-week basis. Our sales guidance implies a low single-digit negative full-year comp sales growth rate. Through six months, we're at a year-to-date comp of negative five-tenths of 1%, and we believe the third quarter will be a mid-single-digit negative, and the fourth quarter could claw back close to flat. There is a deteriorating sales curve and not one of momentum, which causes us to pause The slight sequential improvement built into this guidance for Q4 assumes that the macro environment will stabilize and that our consumer-driven marketing initiatives will begin to show progress. We are feeling our customer pulling back, but that certainly hasn't at all dampened our long-term prospects or our vision for the future of DXL. I would like to turn the call back over to Harvey to elaborate a bit more on that vision.
spk19: Thanks, Peter. And now I want to get into the topic of where DXL goes from here. What's in store for the company over the next three to five years? I want to let you all know that we've been actively working as a leadership team and with our board to define the road ahead. To set the table for where we see the business headed in the next three to five years, we need to start with the fact that DXL is fundamentally in a different position today as compared to where we were pre-pandemic. Over the past two years, we've essentially recapitalized the company. At the height of the pandemic, we were in heavy debt with no cash to sneak up on the balance sheet, too much excess inventory, and negative shareholder equity. Today, we have no debt, over $60 million of cash and investments on the balance sheet, and our shareholder equity is over $150 million. We have achieved a level of operational excellence, more profitable margins with strong free cash flow, faster inventory turnover, and newly developed digital muscles to match our store expertise and experience. We have a world-class merchandise assortment, carrying every major brand a guy can want, from private brands to national designer brands. We have recruited and developed a first-class leadership team that understands the big and tall consumer, understands his needs, understands his challenges, and understand what makes him tick. We believe that all this work to complete the foundational improvements were necessary to create the opportunity that is now before DXL. And during our most recent board meeting, there was unanimous support in the belief that over the next three to five years, We can increase our growth rate and we can take this company to the next level. And so here we are. That goes for me too. Some of you may have seen the announcement a little over a week ago that I've agreed to extend my contract as president and CEO into August of 2026. That commitment ensures I will be here another three years to see our growth initiatives through. So let me get right into the three distinct priorities and opportunities that DXL is pursuing and which we believe can significantly raise the growth trajectory of this company in the next three to five years. Perhaps the greatest opportunity that we have in front of us is the opportunity to address our brand's overall awareness levels. This isn't a new revelation that we recently discovered. Awareness level has been a challenge for some time. What's different is that for all the reasons I just outlined, now we are able to do something about it. According to our most recent consumer research, brand awareness represents one of our greatest opportunities. The customers who know us love the experience and our offer. However, many customers in the sector simply do not know who DXL is. This coupled with a new, compelling, differentiated, and ownable positioning provides us the opportunity like never before to share our stories, connect with customers, and then invite them into an engaging relationship. Historically, one of the reasons we have struggled with awareness is that we haven't rooted our messaging in a differentiated position and couldn't justify the brand spend. This on an absolute and consistent spending level. For the past several years, we've pushed our ad-to-sales ratio from sub-5% to sub-6%. While we are not ready yet to commit to a hard and fast number for ad to sales ratio for the next few years, we know it is going to increase. We know we need to invest more in brand building and top of funnel marketing to grow our customer file. This cannot be a one and done exercise to build awareness. We need a consistent, steady message in the marketplace. As I already noted, part of the reason for not doing this sooner is that we were just not confident that we had the right brand strategy in place, but we are confident now. Another reason is that we are still getting our financial house in order and building a war chest, both in marketing expertise and financial resources, to invest in our own future growth. We can go back and pull up multiple brand awareness campaigns that DXL has historically tried over the years. But the harsh reality is that DXL never had a relevant, consistent marketing campaign. Today, our marketing and positioning are driven by DXL's position as defined by him and not by us. And now with appropriate funding that we will invest over time and over multiple seasons, that will change. What's different today? First, A little less than a year ago, we added a chief digital and analytics officer in addition to our chief marketing officer, effectively doubling our expertise in the marketing suite. We also brought in some stellar supporting team members to augment and fortify our capabilities. We've invested in market research and customer reception studies that have clearly led us to a path that began with our trademark call to action wear what you want, or hashtag WWYW, as we often refer to it. And now we have a better understanding of what motivates our different customers and different segments. Perhaps most important of all, we are now on firm financial footing that will allow us to properly invest in this kind of long-term brand pursuit. We believe that the total addressable market in big and tall men is $23 billion, and we now have the financial flexibility to do something about our lack of market share. While we currently hold a meaningful slice of the better and best market, we have far greater opportunity. That decision won't be a trade-off. We have already targeted a 10% adjusted EBITDA. In the last few years, we have achieved that milestone, but we are still not growing sales to the level we believe is attainable. If we are going to invest 3% to 4% in more brand-building marketing, that growth will come out of adjusted EBITDA margins. We believe that over the next three to five years, we can scale and grow the top line in low double digits and take market share profitably. but it is unlikely to be at the greater than 10% adjusted EBITDA margin that we have enjoyed over the past two years. We are faced with the prospect of being a $550 to $600 million company at 12.5% EBITDA or aiming higher and emerging over the next three to five years from now with a significantly greater top line and greater scale to then leverage our operating model. This is a watershed moment for DXL. And we are all in on building the business to create a far greater scale. The second opportunity that we believe is going to push our top line is store development. I'm happy to report that later this year, we'll be opening our first of three new stores since 2018. One store will be in New York, one in Los Angeles, and one store in Cincinnati. We believe the number of new DXL stores is going to grow to 10 stores in 2024 and at least 15 to 20 in 2025. Overall, we believe there are upwards of 50 net new store opportunities, and as we hone our plans, we will look to drive even more. The new store development addresses another critical limiting factor to our growth. While we have stores in every major metro market across the U.S., there are certainly voids where big and tall consumers are not being serviced by a DXL. In our most recent consumer research across 2,500 customers and non-customers, 49 percent self-reported they do not shop with us because a store is not near to them, while 37% self-reported they do not shop with us because a store is not conveniently located near them. As we have shared previously, we believe there is a path to open new stores with strong sales per square foot, strong sales to invested capital, and a sufficient return on investment. In addition to new stores, We are close to completing six conversions of Casual Mail XL stores to DXL, and we expect to complete four more by the end of 2023. And finally, we've begun work on our lab concept remodeling, and we expect to begin work shortly on one of our DXL stores in the Chicago market while working to evolve the customer experience in at least four additional existing DXL stores before the end of 2023. The third opportunity we see is through collaborations and retail alliances. We believe examples like Untuckit are only the beginning, and we are working in real time on at least a couple more retail brand alliances. We are confident that our fit authority is a leading reason for our being, and as brands realize the difficulty in pursuing greater diversity and inclusion initiatives for their brands and in their offer, Our core capabilities to develop and execute products that serve the big and tall consumer and his needs will be even more in the bullseye of many other great brands. In the same regard, as an alternative means, we are pursuing something I have referred to often, and that is specifically the initiative around fit technology and size mapping. Currently in two stores and rolling out to an additional 10 stores by the end of this month, is a technology platform that will create a compelling in-store and online shopping experience with the use of body scanning for better accuracy and solving for the needs of the big and tall consumer. We look forward to this in time to be both in-store, in concept, across our physical footprint, and in time, a digital feature capable of execution from home as well. And finally, given consistent is defined as what is consistently done, I could not close without acknowledging how inspired I remain for the DXL team we work with every day and the family we have built and achieved over the past four years. None of this would be possible without the hard work and dedication of our people in the stores, in the distribution center, in the corporate office, and the guest engagement center. It is because a great team and culture that I want to get up every morning and keep moving on this journey. Thank you to the entire DXL team for your hard work and commitment in our pursuit of serving big and tall men and making DXL the only place where they would ever choose their own style to wear what they want. And with that, operator, we will now take questions.
spk29: Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To draw your question, press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from Michael Baker with DA Davidson. Your line is open.
spk09: Okay. Thanks, guys. So we love the new store growth, but also love the buybacks. It costs you less than a million dollars, I think, to open a new store. It seems like even if you do 10 or 20, you have plenty of cash left to continue to buy back stock. So I was just wondering, maybe this is a question for the board, but the board's appetite to redo another buyback authorization and keep buying back stock here at the current levels.
spk13: Sure. Thanks for that question, Mike. I'll take that. So you're right, we were pretty aggressive with buying back the stock this past quarter. We feel like that was something that we committed to doing at the beginning of the year and was glad to get that completed. Actually, just yesterday, I think we finished up the remainder of the $15 million authorization. I think with regard to buybacks for the rest of the year, What we are doing for the moment is we're putting together our plans, which Harvey just talked about pretty extensively, about starting to work on longer-term growth plans. I think what we're really focused on is building that, as Harvey said, war chest of cash that we can then figure out what's the best way to deploy that to grow the customer. As I said, buybacks I think are great, and we'll continue to do those when we see that the time is opportunistic. But for right now, we're mostly focused on getting the growth story going.
spk09: Okay. So I guess that doesn't necessarily rule out buybacks is what I'm hearing. Okay. If I could ask another question. Just on the guidance, so you didn't change your gross margin guidance, and I think with my math implies a much better second half gross margin, I think down about 20 basis points in the second half versus the first half. So if you could sort of talk about why you think that, you know, with business weakening a little bit, is there not markdown risk? What we get, you don't want to be promotional, but presumably with sales coming in maybe a little bit lower than you thought, Is there not excess inventory? Do you not need to mark that down? Just how do we think about gross margin in the back half, inventory levels, markdown risk?
spk13: So there's two things that I guess I'll point to in the first half, which will start to improve a bit in the second half with regard to gross margin rate. The first is we will start to lap some of the loyalty programs that started last fall. So that should help a bit. And also, as we talked about, We've seen the customer has definitely been, especially recently, migrating more into private label, which is a better margin rate than our national brands. So, yes, we do expect that margin is going to improve a bit in the second half of the year. And those are two reasons that immediately come to mind as to why.
spk19: The other thing I'll talk about is inventory. We are incredibly comfortable with our inventory as we talked about. It's nearly 10% under last year and over 20% under pre-pandemic. And we're turning goods fast. We're managing inventory. As we mentioned, we had a slight uptick in markdowns because we're managing inventory in the season. It's not a surprise. You've probably heard it elsewhere. Things like shorts and swim are a little difficult. But even with those difficult seasonal businesses, What we said is our markdown rate was nearly at a historical low. So we are confident and comfortable with our inventory. You may recall that we said last quarter we would rather be chasing goods than chasing cancellations. And the merchandising and global sourcing team with the allocation partners are just doing a really, truly a phenomenal job at managing inventory. It is the least of our concerns. Okay. Okay.
spk09: If I could ask one more, I did want to ask about the loyalty program now, I guess not quite a year in, but eight or ten months into it, you're making some changes. How would you characterize the success of that program since November? Are you getting the expected return on investment on that? Why are you making changes because it's not working out as well as you thought? Just if you could sort of talk about that.
spk19: Yeah, it's a really, it's Harvey, it's a really bifurcated outcome. Quite honestly, the two best groups in the loyalty program in terms of tiers are the platinum and gold customer. And honestly, they're almost working out better than we would hope in terms of the utilization of the program. And when I say that, their penetration of revenue to their penetration of the file, their penetration of revenue is probably a little bit greater than we would expect. And conversely, silver and bronze, which are our least engaged customer, and one might make the case that during the environment we're living in, that customer that is buying more based on need than based on want, is not participating as well as we would hope for. And what we're doing is remixing how you gain points and how the program is more uniquely relevant to you. And we're trying to find ways to engage that, what I would call that lower tier customer in bronze and silver to engage and use points and come back. When the day is done, as Peter referred to, points are really, for lack of a better way to say it, some small level of discount on product. But in reality, you cannot typically buy something from us. And so the tickets, The whole point of the program is it creates advocacy and affinity and a greater relationship with us. But they come in, and whether they use the $15 or $30 or $45 worth of certificates, our average spend is still well in excess of $150. So that's the challenge they face, where our better customers more actively engage in buying clothes with us, That's just how they're choosing to spend their, I guess, their discretionary dollars, whether it's need or want, and they are more actively engaged. So we're trying to mix it in a way to leverage that better customer and re-engage at a higher level the lower-tier customer, and hopefully that helps you have some understanding.
spk09: Yeah, it really does. Thanks. I'll pass it on to someone else.
spk28: Thank you. One moment for our next question.
spk29: We have a question from Jeremy Hamblin with Craig Hallam Capital Group. Your line is open.
spk10: Thanks, and congrats on the strong Q2 results. First, just wanted to start with a clarifying question on the gross margin. So you did a 49.5% gross margin in the first half of the year. I think, Peter, your guide and suggestion that's implied would suggest like back half of the year averages about 48.5%. So I know on a relative year-over-year basis, that's better than what you saw in the first half of the year. But on an absolute basis, the second half, I just want to make sure that that's projected in about 48.5% range. Is that correct?
spk13: Yes. I mean, so that's right, Jeremy. Overall, it should be about 100 basis points down from last year, which I think we were 49.9 last year. So, you know, for some of those reasons I highlighted on the previous question, we do expect some improvement in the second half of the year, yes.
spk10: Okay, and then let's focus on the future growth strategy because you went through a few things here, and I know that that plan is still being developed, but I just wanted to make sure that I heard some of the things correct. It sounded like you were planning maybe to invest 3% to 4% of sales in improving brand awareness and that kind of, certainly at least for FY24, maybe FY25, we should be thinking about EBITDA margins that are under 10%. Did I hear that correctly?
spk19: Yep. Conceptually, what we hope and envision is that we will invest in marketing. Part of that investment will be leveraged to P&L through greater sales. And clearly, at least on the onset, part of that marketing will be SG&A increases. and affect the P&L in the short term. When we think about this, and it may be a little hard as a public company, but in reality, we need to invest in this business. We clearly understand what's important to the consumer. We clearly have a positioning that's really important to him based on his terms, and we need to get that message out. And the only way to grow sales is to grow share of market, and the only way to grow share of market is share of voice. So yes, you heard it correctly, but In time, we absolutely, Jeremy, expect leverage and to grow the top line meaningfully greater.
spk13: Jeremy, the only thing that I would add to Harvey's question is, yes, any investment in marketing, incremental investment, if we go from 6% to 9%, and that's 3% more, on a 12% EBITDA margin, you're down to 9% doing real simple math. But that's assuming that you're not growing the sales base at all. And I think our hope is that there's going to be some return from that sale, that investment. Certainly, it'll come the longer you go out. But I think there is some hope and expectation that once we start making that investment, we'll start to see small rates of growth.
spk10: For sure. In terms of, you know, that stuff always takes some time. I think that your advertising, you know, budget for this year is in the $30 million to $35 million range. So I think, again, just quick math here, you're looking at maybe a $15 million to $20 million increase for next year. You know, is there... Obviously, you'd need to give an initiative like this time, which presumably is at least the next 12 months. Is there, you know, kind of a target here over, let's say, a three-year period where you think, you know, sales can be at X and, you know, is that X like $700 million? Or can you give us a sense of what you think that incremental investment can result in?
spk19: Yeah, it's Harvey. The way we've characterized it, and I'm going to be cautious because I don't want to give out competitive insights for lack of a better way to say it, but you should expect to see heightened advertising in very specific ways that are oriented around the positioning and the brand, and that will take some time, and it's not, quote, unquote, going to be more SEM digital marketing, and hopefully you can kind of connect more broad-based advertising but yet still targeted media communication. And the expectation, which we communicated in our previously communicated comments on this call, were that we would expect to see low double digit growth, sustainable for some period of time when that advertising is queued up and engaged in the consumer. So your reference, without specifically giving a number, of $700 million from a 550 base and change on multiple years stacked up of double-digit growth, plus the new store openings, plus top performance, which we've previously talked about being better than average growth, Remember, I'll remind you, we typically think that a good consumer retail business will run comps of one or two points. We would expect to be north of that. And the digital business has historically operated between, let's say, 10 and 15% growth rates for quite some time, barring the pandemic challenges and volatility. We would expect to be north of that. So you have a comp base that is pretty significant, you know, 3% plus in stores. 15% plus online, and then you add to it new share of voice and new market, and you would ultimately get to growth rates that are double-digit. We've characterized them as low double-digit, but you may characterize the growth company differently than us, but we believe a growth company would be meaningful growth, and we've characterized that as low double-digit.
spk10: No, thanks. That's super helpful, Collin, and certainly low double-digit growth, that's for sure a growth company in retail.
spk19: Yeah, the only other thing, Jeremy, I just want to caution you, as I said, without sharing competitive intelligence for lack of a better way to say it, that double-digit growth and low double-digit over time, we expect to see those years back to back to back. The question will be really when is that fully queued up, And we're certainly not going to make that investment, you know, given the last four months of this year. So one would expect you'll see greater investment in 2024 and over 2024, 2025 sales ramp, and then hopefully can continue to maintain that level of increased low double digit performance.
spk10: Now understood clearly, you know, it doesn't happen overnight. I wanted to, Just get a little bit of color, you know, Peter, Harvey, on the unit growth. And thank you for the additional color on that for outlining what next year would look like. In terms of the cadence on the 10 openings for next year, you know, at this point in time, can you provide a little color on is that likely to be more back half of the year loaded? I'm not sure what your lease commitments and your real estate team are projecting in terms of thinking about how that might play out in 2024. Sure.
spk13: So just a little color on that. As we mentioned, we've got the first three are opening this fall, which we're really excited about. For the 10 next year, Um, we have seven that we've identified. We don't have leases signed yet, but we have seven that we, we feel, um, feel good about. Um, some of those will open in the first half. Um, some will open in second half, but it's, it's not like they will all be, um, we don't expect that they will all be back loaded into, um, third and fourth quarter. There'll be some there, but I would expect, um, you know, maybe four in the first half, six in the second half, something like that.
spk10: Got it. That is helpful color. All right, guys, I'll hop out of the queue, but, you know, congrats and best wishes. Thanks, Jeremy.
spk29: Thank you. Our next question will come from Rafi Savitz. With RYS, your line is open.
spk03: Hey, good morning, guys. Maybe one bigger picture question for Harvey and then a couple of quick financial questions for Peter. Harvey, how do you think about kind of a longer-term impact on the business from kind of the new class of weight loss drugs, especially as they become more available, lower cost, and maybe in a pill form kind of over time?
spk19: Yeah, Rafi, great question. It's actually been the number one question, I kid you not, on every investor call for the last 90 days. We actually think it is potentially a catalyst for our business. It's unfortunate, and I say it's unfortunate because although those drugs are absolutely helping and we've heard about great stories, if you're a 5X, you have the potential to become a 3X, but you're not going to move from a 5X to a large. If you're a 3X, you're going to maybe move to a 1X. So there is, first of all, a catalyst for as you diet and lose weight, you need new clothes. The other part that is interesting, and I'm not sure it's unfortunate, it's just what it is, it really requires lifestyle change. And so I don't think anyone intends to be on that drug forever. And if you don't change your lifestyle, it unfortunately creates a yo-yo. And we've heard that already. We've heard a couple of our investors literally say they've been on it. They need to go back to their doctor, get a prescription refill. And their doctor wanted to chat with them before that. It took them three weeks and they gave five pounds back. And I tell you all that because that's more catalyst for the unfortunate reality of going up and down. And our consumer, first of all, is big and tall. And if you're 6'5", And, you know, 280, you're not going to go to, you know, 65 and 180. It's unlikely you'll ever get below a big and tall size. You just might change your size. And then equally, potentially unfortunate if you're on it and you get off it and you don't have lifestyle changes, you potentially could gain weight back. So, you know, for us as a business, we see it as a catalyst. We're hopeful that, you know, our consumer becomes healthier, loses weight and all those things. which of course you would want, but in reality, the practical reality, he's not going to move out of big and tall in most cases. He's just going to really require new clothes for a loss in weight and potentially might require new clothes for a gain back of some of that. So hopefully that helps you understand how we're thinking about it. We really haven't baked anything in, but as we talk and explore this, we do think it's a catalyst for greater business opportunity just because of changing sizes.
spk03: A very, very helpful context. And then, Peter, just a couple of hopefully quick financial questions. I guess from a capital allocation standpoint, how are you thinking about hurdle rates for these various investments, whether it's the stores, whether it's kind of brand investments or any other investments you're kind of making in the business? And then there's the simple one on cash taxes. You talked about cash taxes this year, but how do we think about cash taxes out for the next few years?
spk13: Sure. So I'll take the last one first. So cash taxes out for the next couple of years. You know, it's going to depend on just where we come in with with net income. But I do think this year will be very low cash taxes. Next year we will be very low. But once we get through 2024, we will start to be reaching the end of the NOL usage. So I would say once you get out into 25, 26, we'll be back to sort of more normalized cash tax cycles. I think when it comes to investments, you know, we, I think, do a pretty good job of holding ourselves to a pretty high standard. For example, when we're opening stores, we're looking at, we want to make sure that on a sales per square foot basis, we believe that our new stores that we're opening can achieve sales per square foot levels that we would consider in the top quartile of our store portfolio, whether they actually do that or not. You know, we've got to wait until we get them open, but at least going into it, we'll have an expectation. We also look real carefully at sales to invested capital. I think for us to be able to invest a dollar in capital in in return 1.5 dollars let's say in sales um you know is something that we're we're interested in doing and then finally we look at um internal rate of return and if as long as we're getting a 20 25 plus irr we typically consider that a good capital investment but again it's it all comes back to um it's how can we grow the top line and um We want to make sure that we're putting money to work that can grow the top line but can grow it responsibly.
spk03: And on that note, in terms of the new stores, I guess as you're thinking about a few stores this year and then maybe 10 stores next year and more beyond that, I guess How many of these leases do you expect to sign near-term versus waiting and seeing how at least this cohort of new stores does before going out and committing to a larger new development program?
spk13: The number that we've been talking about is 50 new stores. And the cadence of getting those open, three this year and 10 next year, so that's 13 of the 50 by the end of next year. By that time, we should start getting a decent read on how these stores are opening up. And then the following year, maybe it's 15 to 20. But I think it'll be a good year before we have a real solid read on how the actual performance is. We're encouraged, and we wouldn't be pursuing them if we weren't hearing from our customers that the biggest obstacle to them shopping with us is often that there's not a store in their location or in their market, or it's just inconvenient to drive to whatever the nearest store is. Got it.
spk02: Thanks for the context, guys.
spk19: Thanks, Rafi. Listen, it's Harvey and Peter, and we'll sign off now. We want to thank everyone for attending the call today. We greatly appreciate your interest in DXL, and we're excited about the opportunities yet ahead. And hopefully, as we've articulated, we'll navigate through these continuing challenging times well and well enough to really get to the bigger opportunity of double-digit growth and meaningful engagement with a broad-based customer. So thanks much. Have a great early fall, and we will talk to you in 90 short days.
spk29: This concludes today's conference call.
spk28: Thank you for participating. You may now disconnect. Thank you. you music Thank you. Thank you. Thank you. Good day, and thank you for standing by.
spk29: Welcome to the second quarter 2023 Destination XL group earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising you your hand is raised. To draw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Shelly Mokas, Vice President of SEC Financial Reporting. Please proceed.
spk01: Thank you, Catherine, and good morning, everyone. Thank you for joining us on Destination XL Group's second quarter fiscal 2023 earnings call. On our call today are our President and Chief Executive Officer, Harvey Cantor, 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.dxhelp.com for an explanation and reconciliation of such measures. Today's discussion also contains certain forward-looking statements concerning the company's sales and earnings guidance, long-range strategic plan, and other expectations for fiscal 2023. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those assumptions mentioned today due to a variety of risks and 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 Cantor. Harvey?
spk19: Thank you, Shelley, and good morning, everyone. It's great to have this opportunity to speak with all of you today. Today's agenda for our prepared remarks is a little different than a historical practice. As always, I'm going to talk about our quarterly results and then share with you some of our thoughts and expectations for the second half of the year. But equally important, I want to start sharing with you some perspectives today on where DXL is heading and our vision for the next chapter in the DXL story. When I joined the company back in 2019, What attracted me most to the company was an incredible business model serving an underserved customer that had the potential to scale. Since late 2020, and despite the pandemic, we have made tremendous progress in building process, structure, and discipline, which provides the foundation to position the company for greater rates of growth. The results we achieved in fiscal 2021 and 2022 illustrate that progress. Given 2023's macroeconomic challenges, the goal of sustained double-digit growth is eluding us, but we do believe it is still to come. Today, we are announcing our plan to meaningfully accelerate growth at DXL through three distinct pursuits, which I'll discuss later in the call. But let me be clear, clear about this. We believe greater growth is on the horizon. My comments in the latter part of the prepared remarks We'll give you a sense of how we are thinking about greater growth and begin to define our roadmap for the next three-plus years. But before we talk about the future, let me get started with a quick review of the current quarter's results. On our last earnings call in May, we talked about how we expect our comp sale results for a full year to be approximately flat. And for the second quarter, we expected a low single-digit negative comp. In the second quarter, we did, in fact, post a low single digit negative comp of minus 1.4% as we guided to. The trajectory of our comp performance improved slightly as the quarter progressed. In May, we saw comp sales decline 2.8%. In June, comp sales improved to a negative 1.7%, and in July, comp sales were positive at plus 1%. In stores, traffic was tepid, and our dollars per transaction were down slightly, primarily due to fewer units per transaction and some level of the consumer trading down from national brands into our private brands. This resulted in a second quarter comp decrease of minus 1.4% for stores, and in the digital space, a comp sale decrease of minus 1.3%, with traffic to the website and app up slightly, while dollars per transaction were down slightly, and conversion was roughly flat. Continuing with the second quarter, one of the very brightest areas for this quarter is inventory. We are turning our goods faster, and our Q2 inventory balance is down 9.5% versus last year and down 20.7% versus 2019. Our merchandising, planning, allocation, and global sourcing teams have worked proactively to manage receipt flow and strategically execute programs to prevent any bloating of our inventory and our balances. This did lead to a slight increase in markdown levels compared to last year, but we are in a very favorable inventory position as we head into fall with markdown levels that are still very near historical lows. Our clearance inventory at the end of Q2 2023 is 9.3% as compared to 6.9% at the end of Q2 and fiscal 22. We are very comfortable with our clearance inventory levels, which are still less than our target of 10%. From a merchandising perspective, our formal sportswear and tailored clothing categories such as sport coats, sport shirts, and casual bottoms performed well in Q2. Seasonal product categories such as shorts and swim underperformed our expectations. Sales in tailored clothing increased 4% to last year and made up 16% of the total sales penetration compared to 15% last year. As a reminder, our current merchandise assortment is a balance of private brands and national brands. And in Q2, we did experience a shift into our private brands, as I noted earlier. with approximately 15%, 55% of our sales driven by our own brands and 45% driven by national brands. As I mentioned on our last quarterly call, we have two more iconic brands that are set to launch with DXL. I'm very pleased to report that Faraday and Hugo Boss are both joining our portfolio brands this fall. Both brands will be available in selected stores and online. Verity is exclusive to DXL in big and tall sizes, while Hugo Boss is delivering exclusive big and tall product capsules, meaning in both examples, you cannot find this product anywhere else. Also, we are launching a third brand as a collaborative effort with another iconic retailer. In September, we will be launching Untuckit, fit by DXL, in partnership with Untuckit. This brand edition will be exclusively sold by DXL, but marketed jointly by both Untuckit and DXL. Driven by a reputation for fit and Untuckit's product and brand following, we believe this is going to be a wonderful strategic alliance and a big win for the big and tall man. These brand editions and collaborations give us great confidence that DXL brand is building a reputation with other great retail brands as the place to be if you want to make your brand available to big and tall consumers. It really is an exciting time for us at VXL, and we are 100% oriented around growing this business. Let me also now touch a bit on marketing and advertising. There are a number of foundational improvements that we have been working on this past year, and a few are worthy of highlighting today. One is email deployment, which is critical to get right. We continue to make good progress on our long-term goal of developing more sophisticated ways to approach segmentation and personalized communication with our customers, including using modern software platforms such as our CDP. During the quarter, we launched an upgraded capability to deliver more relevant, personalized, and individual behavior-based email communication to our customers in near real time. Consumer engagement has been excellent and likewise an improvement in revenue. We look forward to extending these capabilities to additional areas of customer need. This is but one further step in our journey to personalize and derive more uniquely relevant marketing communication based on actual personal shopping behavior. Another example of foundational improvements is the user experience on our app and on our browser-based website. Enhancements on both platforms have been developed and executed to specifically drive increases in conversion and have largely been defined by consumers' actual online engagement. In our app, for example, we've improved the design of our product catalog and product detail pages to address specific points of customer drop-off. And on our site, We've made updates to our navigation to increase customer engagement with our most valuable content. Next is our loyalty program, which was revamped and introduced last November. The loyalty program continues to evolve to increase active engagement, building upon affinity, which is what we envisioned from the onset. The second quarter was really focused on framing loyalty messaging better and engaging the consumer in more meaningful ways. To do this, we stopped auto enrollment and doubled down on communicating why they should want to be part of DXL's loyalty program. We did this because we saw meaningful differences in tier levels of loyalty program cohorts, and ultimately, it was about the utilization of the program, not absolute membership. Because the loyalty program is about how we treat our customers, our very best customers, in unique and engaging ways, We want the loyalty program to mean something special and provide something different to our customers than just shop and save. The elimination of auto-enrollment creates a slowdown in loyalty acquisition, but it will in time improve brand affinity, or so we believe, through self-enrollment and then greater engagement, which ultimately leads to greater advocacy. Now let me touch on the second half, which is off to a tough start. So far, through the first three weeks of the third quarter, our combined comp sales rate is down 6.5%. The themes of why business has been tough are the same we have identified already, traffic, ticket, and conversion. Despite the slow start to third quarter, we remain relentlessly focused on five critical areas, file, relevant personalization, traffic, brand awareness, and customer experience to engage and serve the big and tall consumer. We are deploying specific tactics in each of these areas to encourage greater visits and avoid customer lapses. Some of our initiatives include path to purchase, the rollout of greater behavioral-based email triggers, upper funnel print media in the holiday season, and a rebalancing of the paid media investment mix Our path to success is grounded in improved traffic levels and ultimately better customer acquisition and retention. We are poised to begin refocusing on the brand's awareness and DXL's unique, differentiated position to serve the big and tall consumer like no one else can. And that's really what I want to spend the remainder of my time to talk about with you today. But before I do that, I'm going to ask Peter to run through the second quarter financials and how we are thinking about guidance for the remainder of the year. After that update, I'll come back on and talk to you about the next steps. Peter?
spk13: Thank you, Harvey, and good morning, everyone. I won't rehash the comps that Harvey already spoke to and are available in the press release we filed this morning. However, I will note that net sales for the second quarter were $140 million as compared to $144.6 million in the second quarter of last year. Our sales in the second quarter were impacted by lower dollars per transaction because customers purchased fewer units and, in some cases, traded down to lower-priced options, which we believe is a result of inflationary pressures impacting discretionary spending. The sequential improvement in sales as the quarter progressed was a result of improved traffic to our stores and growth in our mobile app and email marketing. Traffic, ticket, and conversion are core KPIs we will continue to pursue as we look to drive results in the second half of the year. Moving on to gross margin, our gross margin rate inclusive of occupancy costs was 50.3% as compared to 52.1% in the second quarter of last year. This 180 basis point decrease was a combination of 110 basis points in merchandise margin and 70 basis points in occupancy costs, primarily due to the deleveraging of sales and increased rents from lease extensions. The margin rate decline from last year's record high levels was in line with our expectations. We have remained low promotional, choosing to emphasize our superior quality, fit, and experience rather than discount prices, and our margin rate remains significantly higher than our historical rate. However, on a year-over-year basis, margins decreased due to a combination of higher costs in three areas consistent with last quarter. First, we decided to absorb the cost increases on certain private label merchandise, especially those at an opening price point level, rather than passing these on to our customer through price increases. Second, costs related to the fulfillment of direct-to-consumer orders continue to be elevated. And third, The success of our new loyalty program means that there are more customers redeeming loyalty certificates for a discount on their purchase. These three factors were partially offset by lower inbound freight costs on receipts from overseas. Although each of these elements will persist at varying levels through the rest of the year, we expect them to moderate to the point where gross margin rates for the year should be approximately 100 basis points lower than last year. Turning next to selling general and administrative expenses, our SG&A expense as a percentage of sales decreased to 33.9% as compared to 34.2% in the prior year's second quarter. On a dollar basis, SG&A expense decreased by $2 million, allowing us to improve by 30 basis points despite the lower sales. The decrease was primarily from lower performance-based incentive accruals and marketing costs, partially offset by new positions added in the past year to support our long-term growth initiatives, including new store development. Our add to sales ratio decreased slightly to 5% from 5.4% in Q2 of last year. For the year, we still expect to spend about 5.7% of sales on advertising. And as you might expect, we are being very judicious with expense management but we remain committed to investing in the people and technology necessary to support our future growth plans. With gross margin at 50.3% and SG&A expense at 33.9%, this brings our adjusted EBITDA in at 16.4%, or $22.9 million for the second quarter. Although lower than last year's 17.9%, We are pleased with this result of being able to deliver a mid-double digit adjusted EBITDA margin rate for Q2 in the current sales environment. I want to spend a minute on one unusual transaction that occurred this quarter and will have some limited impact later this year as well. We are taking advantage of a unique opportunity to strengthen our balance sheet and reduce P&L volatility. we are terminating our legacy pension plan, which was frozen over 20 years ago and has been on our radar for quite some time. Due to the current interest rate environment, the termination gap between our pension liability and our pension assets is at its lowest level in at least the last 10 years. During Q2, we made a cash contribution of $1.6 million to the plan, And we recognize a non-operating charge of $4.2 million to flow the previously unrealized loss through the P&L. As of July 29, 2023, approximately 78% of the pension obligation has been paid, with the remaining 22% expected to be paid in the fourth quarter. At that time, we'll recognize the remaining charge, which we are estimating at approximately $1.5 million, and proceed with finalizing the termination of the plan. Capitalizing on the current interest rate environment to eliminate this variable viability from our books is a prudent and opportunistic use of some of our excess cash, which will benefit our shareholders. Speaking of cash, the balance of our cash in short-term investments grew to $62.8 million as compared to $22.2 million a year ago. With no outstanding debt in either period, and availability of $81.8 million under our revolving credit facility. This improvement was on the strength of our free cash flow, which we define as cash flow from operating activities, less capital expenditures, which was $21.6 million for the six months to date. We continue to keep our excess cash invested in short-term U.S. government treasury bills, which are earning interest at approximately 5%. We also used some of this free cash flow to repurchase our stock on the open market. Over the course of the quarter, we spent $10.8 million to repurchase 2.2 million shares at an average cost of $4.81 per share. At the end of the quarter, that left us with approximately 4.1 million of our board's original $15 million authorization which we have already fully utilized in the first three weeks of the third quarter. At the moment, we do not have plans for further repurchase activity this year. Harvey is going to talk in a minute about our growth plans, and we are very happy to have this cash available and the financial flexibility to fund and execute those growth plans. Before I conclude with our outlook for the second half, I just want to spend a moment on income taxes since this is an area where our year-over-year results require adjustment for comparative purposes. Last year, our second quarter results reflected a tax benefit of 35.1 million, which included the release of 35.5 million, or 53 cents per share, in valuation allowance reserves. Now that those valuation allowances have been removed, we have returned to a more normal tax rate of approximately 26%. However, we are still able to utilize our remaining net operating loss carry forwards to reduce our cash taxes. And as a result, we'll pay very little in federal or state cash income tax in fiscal 2023. As a reminder, we began the year with $78.9 million in federal net operating loss carry forwards. Finally, I'll close with an update on our financial outlook for fiscal 2023. which we are trimming today in response to the difficult macro environment and ongoing volatility we are expecting in the second half of the year. Our updated guidance is for net sales of 535 to 545 million in an adjusted EBITDA margin of approximately 11 to 12% on a 53-week basis. Our sales guidance implies a low single-digit negative full-year comp sales growth rate. Through six months, we're at a year-to-date comp of negative five-tenths of 1%, and we believe the third quarter will be a mid-single-digit negative, and the fourth quarter could claw back close to flat. There is a deteriorating sales curve and not one of momentum, which causes us to pause. The slight sequential improvement built into this guidance for Q4 assumes that the macro environment will stabilize, and that our consumer-driven marketing initiatives will begin to show progress. We are feeling our customer pulling back, but that certainly hasn't at all dampened our long-term prospects or our vision for the future of DXL. I would like to turn the call back over to Harvey to elaborate a bit more on that vision.
spk19: Thanks, Peter. And now I want to get into the topic of where DXL goes from here. What's in store for the company over the next three to five years. I want to let you all know that we've been actively working as a leadership team and with our board to define the road ahead. To set the table for where we see the business headed in the next three to five years, we need to start with the fact that DXL is fundamentally in a different position today as compared to where we were pre-pandemic. Over the past two years, we've essentially recapitalized the company. At the height of the pandemic, we were in heavy debt with no cash to sneak up on the balance sheet, too much excess inventory, and negative shareholder equity. Today, we have no debt, over $60 million of cash and investments on the balance sheet, and our shareholder equity is over $150 million. We have achieved a level of operational excellence, more profitable margins with strong free cash flow, faster inventory turnover and newly developed digital muscles to match our store expertise and experience. We have a world-class merchandise assortment carrying every major brand a guy can want from private brands to national designer brands. We have recruited and developed a first-class leadership team that understands the big and tall consumer, understands his needs, understands his challenges, and understand what makes him tick. We believe that all this work to complete the foundational improvements were necessary to create the opportunity that is now before DXL. And during our most recent board meeting, there was unanimous support in the belief that over the next three to five years, we can increase our growth rate and we can take this company to the next level. That goes for me, too. Some of you may have seen the announcement a little over a week ago that I have agreed to extend my contract as President and CEO into August of 2026. That commitment ensures I will be here another three years to see our growth initiatives through. So let me get right into the three distinct priorities and opportunities that DXL is pursuing and which we believe can significantly raise the growth trajectory of this company in the next three to five years. Perhaps the greatest opportunity that we have in front of us is the opportunity to address our brand's overall awareness levels. This isn't a new revelation that we recently discovered. Awareness level has been a challenge for some time. What's different is that for all the reasons I just outlined, now we are able to do something about it. According to our most recent consumer research, brand awareness represents one of our greatest opportunities. The customers who know us love the experience and our offer. However, many customers in the sector simply do not know who DXL is. This coupled with a new, compelling, differentiated, and ownable positioning provides us the opportunity like never before to share our story, connect with customers, and then invite them into an engaging relationship. Historically, one of the reasons we have struggled with awareness is that we haven't rooted our messaging in a differentiated position and couldn't justify the brand spend. This on an absolute and consistent spending level. For the past several years, we've pushed our add to sales ratio from sub 5% to sub 6%. While we are not ready yet to commit to a hard and fast number for add to sales ratio for the next few years, we know it is going to increase. We know we need to invest more in brand building and top of funnel marketing to grow our customer file. This cannot be a one and done exercise to build awareness. We need a consistent, steady message in the marketplace. As I already noted, part of the reason for not doing this sooner is that we were just not confident that we had the right brand strategy in place, but we are confident now. Another reason is that we are still getting our financial house in order and building a war chest. both in marketing expertise and financial resources, to invest in our own future growth. We can go back and pull up multiple brand awareness campaigns that DXL has historically tried over the years. But the harsh reality is that DXL never had a relevant, consistent marketing campaign. Today, our marketing and positioning are driven by DXL's position as defined by him and not by us. And now with appropriate funding that we will invest over time and over multiple seasons, that will change. What's different today? First, a little less than a year ago, we added a chief digital and analytics officer in addition to our chief marketing officer, effectively doubling our expertise in the marketing suite. We also brought in some stellar supporting team members to augment and fortify our capabilities. We've invested in market research and customer reception studies that have clearly led us to a path that began with our trademark call to action, wear what you want, or hashtag WWYW, as we often refer to it. And now we have a better understanding of what motivates our different customers and different segments. Perhaps most important of all, We are now on firm financial footing that will allow us to properly invest in this kind of long-term brand pursuit. We believe that the total addressable market in big and tall men is $23 billion, and we now have the financial flexibility to do something about our lack of market share. While we currently hold a meaningful slice of the better and best market, we have far greater opportunity. That decision won't be without tradeoffs. We have already targeted a 10% adjusted EBITDA. In the last few years, we have achieved that milestone, but we are still not growing sales to the level we believe is attainable. If we are going to invest 3% to 4% in more brand-building marketing, that growth will come out of adjusted EBITDA margins. We believe that over the next three to five years, we can scale and grow the top line in low double digits and take market share profitably. but it is unlikely to be at the greater than 10% adjusted EBITDA margin that we have enjoyed over the past two years. We are faced with the prospect of being a $550 to $600 million company at 12.5% EBITDA or aiming higher and emerging over the next three to five years from now with a significantly greater top line and greater scale to then leverage our operating model. This is a watershed moment for DXL. And we are all in on building the business to create a far greater scale. The second opportunity that we believe is going to push our top line is store development. I'm happy to report that later this year, we'll be opening our first of three new stores since 2018. One store will be in New York, one in Los Angeles, and one store in Cincinnati. We believe the number of new DXL stores is going to grow to 10 stores in 2024 and at least 15 to 20 in 2025. Overall, we believe there are upwards of 50 net new store opportunities, and as we hone our plans, we will look to drive even more. The new store development addresses another critical limiting factor to our growth. While we have stores in every major metro market across the U.S., there are certainly voids where big and tall consumers are not being serviced by a DXL. In our most recent consumer research across 2,500 customers and non-customers, 49 percent self-reported they do not shop with us because a store is not near to them, while 37% self-reported they do not shop with us because a store is not conveniently located near them. As we have shared previously, we believe there is a path to open new stores with strong sales per square foot, strong sales to invested capital, and a sufficient return on investment. In addition to new stores, we are close to completing six conversions of casual mail XL stores to DXL, and we expect to complete four more by the end of 2023. And finally, we've begun work on our lab concept remodeling, and we expect to begin work shortly on one of our DXL stores in the Chicago market while working to evolve the customer experience in at least four additional existing DXL stores before the end of 2023. The third Opportunity we see is through collaborations and retail alliances. We believe examples like Untuckit are only the beginning and we are working in real time on at least a couple more retail brand alliances. We are confident that our fit authority is a leading reason for our being and as brands realize the difficulty in pursuing greater diversity and inclusion initiatives for their brands and in their offer, Our core capabilities to develop and execute products that serve the big and tall consumer and his needs will be even more in the bullseye of many other great brands. In the same regard as an alternative means, we are pursuing something I have referred to often, and that is specifically the initiative around fit technology and size mapping. Currently in two stores and rolling out to an additional 10 stores by the end of this month, is a technology platform that will create a compelling in-store and online shopping experience with the use of body scanning for better accuracy of fit and solving for the needs of the big and tall consumer we look forward to this in time to be both in store in concept across our physical footprint and in time a digital feature capable of execution from home as well and finally Given consistent is defined as what is consistently done, I could not close without acknowledging how inspired I remain by the DXL team we work with every day and the family we have built and achieved over the past four years. None of this would be possible without the hard work and dedication of our people in the stores, in the distribution center, in the corporate office, and the guest engagement center. It is because of the great team and culture that we created that I want to get up every morning and keep moving on this journey. Thank you to the entire DXL team for your hard work and commitment in our pursuit of serving big and tall men and making DXL the only place where they would ever choose their own style to wear what they want. And with that, operator, we will now take questions.
spk29: Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To draw your question, press star 1-1 again. Please stand by while we compile the Q&A roster. Our first question comes from Michael Baker with DA Davidson. Your line is open.
spk09: Okay. Thanks, guys. So... We love the new store growth, but also love the buybacks. It costs you less than a million dollars, I think, to open a new store. It seems like even if you do 10 or 20, you have plenty of cash left to continue to buy back stock. So I was just wondering, maybe this is a question for the board, but the board's appetite to redo another buyback authorization and keep buying back stock here at the current levels.
spk13: Sure. Thanks for that question, Mike. I'll take that. So you're right, we were pretty aggressive with buying back the stock this past quarter. We feel like that was something that we committed to doing at the beginning of the year and was glad to get that completed. Actually, just yesterday, I think we finished up the remainder of the 15 million authorization. I think with regard to buybacks for the rest of the year, What we are doing for the moment is we're putting together our plans, which Harvey just talked about pretty extensively, about starting to work on longer-term growth plans. You know, I think what we're really focused on is building that, as Harvey said, war chest of cash that we can then figure out what's the best way to deploy that to grow the customer. As I said, buybacks I think are great, and we'll continue to do those when we see that the time is opportunistic. But for right now, we're mostly focused on getting the growth story going.
spk09: Okay. So I guess that doesn't necessarily rule out buybacks is what I'm hearing. Okay. If I could ask another question. Just on the guidance, so you didn't change your gross margin guidance, and I think with my math implies a much better second half gross margin, I think down about 20 basis points in the second half versus the first half. So if you could sort of talk about why you think that, you know, with business weakening a little bit, is there not markdown risk? What we get, you don't want to be promotional, but presumably with sales coming in maybe a little bit lower than you thought, Is there not excess inventory? Do you not need to mark that down? Just how do we think about gross margin in the back half, inventory levels, markdown risk?
spk13: So there's two things that I guess I'll point to in the first half, which will start to improve a bit in the second half with regard to gross margin rate. The first is we will start to lap some of the loyalty programs that started last fall. So that should help a bit. And also, as we talked about, We've seen the customer has definitely been, especially recently, migrating more into private label, which is a better margin rate than our national brands. So, yes, we do expect that margin is going to improve a bit in the second half of the year. And those are two reasons that immediately come to mind as to why.
spk19: The other thing I'll talk about is inventory. We are incredibly comfortable with our inventory as we talked about. It's nearly 10% under last year and over 20% under pre-pandemic. And we're turning goods fast. We're managing inventory. As we mentioned, we had a slight uptick in markdowns because we're managing inventory in the season. It's not a surprise. You've probably heard elsewhere things like shorts and swim are a little difficult. But even with those difficult seasonal businesses, What we said is our markdown rate was nearly at a historical low. So we are confident and comfortable with our inventory. You may recall that we said last quarter we would rather be chasing goods than chasing cancellations. And the merchandising and global sourcing team with the allocation partners are just doing a really, truly a phenomenal job at managing inventory. It is the least of our concerns. Okay.
spk09: If I could ask one more, I did want to ask about the loyalty program now, I guess not quite a year in, but eight or ten months into it. You're making some changes. How would you characterize the success of that program since November? Are you getting the expected return on investment on that? Are you making changes because it's not working out as well as you thought? Just if you could sort of talk about that.
spk19: Yeah, it's a really, it's Harvey, it's a really bifurcated outcome. Quite honestly, the two best groups in the loyalty program in terms of tiers are the platinum and gold customer. And honestly, they're almost working out better than we would hope in terms of the utilization of the program. And when I say that, their penetration of revenue to their penetration of the file, their penetration of revenue is probably a little bit greater than we would expect. And conversely, silver and bronze, which are our least engaged customer, and one might make the case that during the environment we're living in, that customer that is buying more based on need than based on want is not participating as well as we would hope for. And what we're doing is remixing how you gain points. and how the program is more uniquely relevant to you. And we're trying to find ways to engage that, what I would call that lower tier customer in bronze and silver to engage and use points and come back. When the day is done, as Peter referred to, points are really, for lack of a better way to say it, some small level of discount on product. But in reality, you cannot typically buy something from us. And so the tickets, The whole point of the program is it creates advocacy and affinity and a greater relationship with us. But they come in, and whether they use the $15 or $30 or $45 worth of certificates, our average spend is still well in excess of $150. So that's the challenge they face, where our better customers more actively engage in buying clothes with us, That's just how they're choosing to spend their, I guess, their discretionary dollars, whether it's need or want, and they are more actively engaged. So we're trying to mix it in a way to leverage that better customer and re-engage at a higher level the lower-tier customer, and hopefully that helps you have some understanding.
spk09: Yeah, it really does. Thanks. I'll pass it on to someone else.
spk28: Thank you. One moment for our next question.
spk29: We have a question from Jeremy Hamblin with Craig Hallam Capital Group. Your line is open.
spk10: Thanks, and congrats on the strong Q2 results. First, just wanted to start with a clarifying question on the gross margin. So you did a 49.5% gross margin in the first half of the year. I think, Peter, your guide and suggestion that's implied would suggest like back half of the year averages about 48.5%. So I know on a relative year-over-year basis, that's better than what you saw in the first half of the year. But on an absolute basis, the second half, I just want to make sure that that's projected in about 48.5% range. Is that correct? Yes.
spk13: Yes. I mean, so that's right, Jeremy. Overall, it should be about 100 basis points down from last year, which I think we were 49.9 last year. So, you know, for some of those reasons I highlighted on the previous question, we do expect some improvement in the second half of the year, yes.
spk10: Okay, and then let's focus on the future growth strategy because you went through a few things here, and I know that that plan is still being developed, but I just wanted to make sure that I heard some of the things correct. It sounded like you were planning maybe to invest 3% to 4% of sales in improving brand awareness and that kind of certainly at least for FY24, maybe FY25, we should be thinking about EBITDA margins that are under 10%. Did I hear that correctly?
spk19: Yep. Conceptually, what we hope and envision is that we will invest in marketing. Part of that investment will be leveraged to P&L through greater sales. And clearly, at least on the onset, part of that marketing will be SG&A increases. and affect the P&L in the short term. When we think about this, and it may be a little hard as a public company, but in reality, we need to invest in this business. We clearly understand what's important to the consumer. We clearly have a positioning that's really important to him based on his terms, and we need to get that message out. And the only way to grow sales is to grow share of market, and the only way to grow share of market is share of voice. So yes, you heard it correctly. But in time, we absolutely, Jeremy, expect leverage and to grow the top line meaningfully greater.
spk13: And Jeremy, the only thing that I would add to Harvey's question is, so yes, any investment in marketing, incremental investment, if we go from 6% to 9%, and that's 3% more, On a 12% EBITDA margin, you're down to 9% doing real simple math. But that's assuming that you're not growing the sales base at all. And I think our hope is that there's going to be some return from that sale, that investment. Certainly, it'll come the longer you go out. But I think there is some hope and expectation that once we start making that investment, we'll start to see small rates of growth.
spk10: For sure. In terms of, you know, that stuff always takes some time. I think that your advertising, you know, budget for this year is in the $30 million to $35 million range. So I think, again, just quick math here, you're looking at maybe a $15 million to $20 million increase for next year. You know, is there... Obviously, you need to give an initiative like this time, which presumably is at least the next 12 months. Is there kind of a target here over, let's say, a three-year period where you think sales can be at X, and is that X like $700 million, or can you give us a sense of what you think that incremental investment can result in?
spk19: Yeah, it's Harvey. The way we've characterized it, and I'm going to be cautious because I don't want to give out competitive insights, for lack of a better way to say it, but you should expect to see heightened advertising in very specific ways that are oriented around the positioning and the brand, and that will take some time, and it's not quote-unquote going to be more SEM digital marketing, and hopefully you can kind of connect, you know, more broad-based but yet still targeted media communication. And the expectation, which we communicated in our previously communicated comments on this call, were that we would expect to see low double-digit growth, sustainable for some period of time when that advertising is queued up and engaged in the consumer. So your reference without specifically giving a number of $700 million from a 550 base and change on multiple years stacked up a double-digit growth plus the new store openings plus comp performance, which we've previously talked about being better than average. Remember, I'll remind you, we typically think that a good consumer retail business will run comps of one or two points. We would expect to be north of that. And the digital business has historically operated between, let's say, 10% and 15% growth rates for quite some time, barring the pandemic challenges and volatility. We would expect to be north of that. So you have a comp base that is pretty significant, you know, 3% plus in stores, 15% plus online. And then you add to it new share of voice and new market, and you would ultimately get to growth rates that are double-digit. We've characterized them as low double-digit, but you may characterize the growth company differently than us, but we believe a growth company would be meaningful growth, and we've characterized that as low double-digit.
spk10: No, thanks. That's a super helpful caller, and certainly low double-digit growth is That's for sure a growth company in retail. Yeah.
spk19: The only other thing, Jeremy, I just want to caution you, as I said, without sharing competitive intelligence for library, was that that double-digit growth at low double-digit over time, we expect to see those years back to back to back. The question will be really when is that fully queued up? And we're certainly not going to make that investment in the last four months of this year because So one would expect you'll see greater investment in 2024 and over 2024 2025 sales ramp and then hopefully can continue to maintain that level of increased low double digit performance.
spk10: Now, understood clearly, you know, it doesn't happen overnight. I wanted to just get a little bit of color, you know, Peter Harvey on the On the unit growth, and thank you for the additional color on that for outlining what next year would look like. In terms of the cadence on the 10 openings for next year, at this point in time, can you provide a little color on is that likely to be more back half of the year loaded? I'm not sure what your lease commitments and your real estate team are projecting in terms of thinking about how that might play out in 2024.
spk13: Sure. So just a little color on that. As we mentioned, we've got the first three are opening this fall, which we're really excited about. For the 10 next year, We have seven that we've identified. We don't have leases signed yet, but we have seven that we feel good about. Some of those will open in the first half. Some will open in the second half, but it's not like they will all be – we don't expect that they will all be backloaded into third and fourth quarter. There will be some there, but I would expect, you know, maybe four in the first half, six in the second half, something like that.
spk10: Got it. That is helpful color. All right, guys, I'll hop out of the queue, but congrats and best wishes. Thanks, Jeremy.
spk29: Thank you. Our next question will come from Rafi Savitz with RYS. Your line is open.
spk03: Hey, good morning, guys. Maybe one bigger picture question for Harvey and then a couple of quick financial questions for Peter. Harvey, how do you think about, you know, kind of a longer term impact on the business from, you know, kind of the new class of weight loss drugs, especially as they become more available, lower cost and maybe in a pill form kind of over time?
spk19: Yeah, Rafi, great question. It's actually been the number one question, I kid you not, on every investor call for the last 90 days. We actually think it is potentially a catalyst for our business. It's unfortunate, and I say it's unfortunate because although those drugs are absolutely helping and we've heard about great stories, if you're a 5X, you have the potential to become a 3X, but you're not going to move from a 5X to a large. If you're a 3X, you're going to maybe move to a 1X. So there is, first of all, a catalyst for as you diet and lose weight, you need new clothes. The other part that is interesting, and I'm not sure it's unfortunate, it's just what it is, it really requires lifestyle change. And so I don't think anyone intends to be on that drug forever. And if you don't change your lifestyle, it unfortunately creates a yo-yo. And we've heard that already. We've heard a couple of our investors literally say they've been on it. They need to go back to their doctor, get a prescription refill. And their doctor wanted to chat with them before that. It took them three weeks and they gave five pounds back. And I tell you all that because that's more catalyst for the unfortunate reality of going up and down. And our consumer, first of all, is big and tall. And if you're 6'5", And, you know, 280, you're not going to go to, you know, six, five and 180. It's unlikely you'll ever get below a big and tall size. You just might change your size. And then equally potentially unfortunate if you're on it and you get off it and you don't have lifestyle changes, you potentially could gain weight back. So, you know, for us as a business, we see it as a catalyst. We're hopeful that, you know, our consumer becomes healthier, loses weight and all those things. which, of course, you would want. But in reality, the practical reality, he's not going to move out of big and tall in most cases. He's just going to really require new clothes for a loss in weight and potentially might require new clothes for a gain back of some of that. So hopefully that helps you understand how we're thinking about it. We really haven't baked anything in, but as we talk and explore this, we do think it's a catalyst for greater business opportunity just because of changing size businesses.
spk03: Very, very helpful context. And then, Peter, just a couple of hopefully quick financial questions. I guess from a capital allocation standpoint, like how are you thinking about hurdle rates for these various investments, whether it's the stores, whether it's, you know, kind of brand investments or any other investments you're kind of making in the business? And then, you know, there's the simple one on cash taxes. You know, you talked about cash taxes this year, but how do we think about cash taxes, you know, out for the next few years?
spk13: Sure. So I'll take the last one first. So cash taxes out for the next couple of years. You know, it's going to depend on just where we come in with with net income. But I do think this year will be very low cash taxes. Next year we will be very low. But once we get through 2024, we will start to be reaching the end of the NOL usage. So I would say once you get out into 25, 26, we'll be back to sort of more normalized cash tax cycles. I think when it comes to investments, we, I think, do a pretty good job of holding ourselves to a pretty high standard. For example, when we're opening stores, we're looking at, we want to make sure that on a sales per square foot basis, we believe that our new stores that we're opening can achieve sales per square foot levels that we would consider in the top quartile of our store portfolio, whether they actually do that or not. You know, we've got to wait until we get them open, but at least going into it, we'll have an expectation. We also look real carefully at sales to invested capital. I think for us to be able to invest a dollar in capital in in return $1.5, let's say, in sales is something that we're interested in doing. And then finally, we look at internal rate of return. And as long as we're getting a 20, 25 plus IRR, we typically consider that a good capital investment. But again, it all comes back to it's how can we grow the top line and We want to make sure that we're putting money to work that can grow the top line but can grow it responsibly.
spk03: And on that note, in terms of the new stores, I guess as you're thinking about a few stores this year and then maybe 10 stores next year and more beyond that, I guess How many of these leases do you expect to sign near-term versus waiting and seeing how at least this cohort of new stores does before going out and committing to a larger new development program?
spk13: The number that we've been talking about is 50 new stores. And the cadence of getting those open, three this year and 10 next year, so that's 13 of the 50 by the end of next year. By that time, we should start getting a decent read on how these stores are opening up. And then the following year, you know, maybe it's 15 to 20. But, you know, I think it'll be a good year before we have a real solid read on how the actual performance is. We're encouraged, and we wouldn't be pursuing them if we weren't hearing from our customers that the biggest obstacle to them shopping with us is often that there's not a store in their location or in their market, or it's just inconvenient to drive to whatever the nearest store is. Got it.
spk02: Thanks for the context, guys.
spk19: Thanks, Rafi. Listen, it's Harvey and Peter, and we'll sign off now. We want to thank everyone for attending the call today. We greatly appreciate your interest in DXL, and we're excited about the opportunities yet ahead. And hopefully, as we've articulated, we'll navigate through these continuing challenging times well and well enough to really get to the bigger opportunity of double-digit growth and meaningful engagement with a broad-based customer. So thanks much. Have a great early fall, and we will talk to you in 90 short days.
spk29: This concludes today's conference call. Thank you for participating. You may now disconnect.
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