Destination XL Group Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 24, 2023

There are 7 speakers on the call.

Operator

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 speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Shelly Mochas, Vice President of SEC Financial Reporting.

Operator

Please proceed.

Speaker 1

Thank you, Catherine, and good morning, everyone. Thank you for joining us on Destination XL Group's Q2 fiscal 2023 earnings call. On our call today are our President and Chief Executive Officer, Harvey Kanter and our Chief Financial Officer, Peter Stratton. During today's call, we will discuss some non GAAP metrics to provide investors with useful information about our financial performance. Please refer to our earnings release, which was filed this morning and is available on our Investor Relations website at investor.

Speaker 1

Dxl.com for an explanation and reconciliation of such measures. Today's discussion also contains certain forward looking statements concerning the company's sales and earnings guidance, long range strategic plan and other expectations for fiscal 2023. Such forward looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those assumptions mentioned today due to a variety of 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 Kanter.

Speaker 1

Harvey?

Speaker 2

Thank you, Shelly, 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.

Speaker 2

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 20212022 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 3 distinct pursuits, which I'll discuss later in the call.

Speaker 2

But let me be clear about this. We believe Greater growth is on the horizon. My comments in the latter part of our prepared remarks will give you a sense of how we are thinking about greater growth and begin to define our roadmap for the next 3 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 the full year to be approximately flat and for the Q2 we expected a low single digit negative comp.

Speaker 2

In the Q2, 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 +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.

Speaker 2

This resulted in a 2nd quarter comp decrease of minus 1.4 percent 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 the Q2, 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 in 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.

Speaker 2

Our clearance inventory at the end of Q2 2023 is 9.3% as compared to 6.9% at the end of Q2 and fiscal 2022. 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 Just 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% The total sales penetration compared to 15% last year.

Speaker 2

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 2 more iconic brands that are set to launch with DXL. I'm very pleased to report that Firdi and Hugo Boss are both joining our portfolio brands this fall. Both brands will be available in selected stores and online.

Speaker 2

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 3rd brand as a collaborative effort with another iconic retailer. In September, we will be launching UNTUCK IT fit by DXL in partnership with UNTUCKit. This brand addition 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 new following, we believe this is going to be a wonderful strategic alliance And a big win for the big and tall man.

Speaker 2

These brand additions and collaborations give us great confidence The 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 adult consumers. It really is an exciting time for us at DXL 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.

Speaker 2

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.

Speaker 2

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 envision from the onset.

Speaker 2

The Q2 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 is 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 In 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 our 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.

Speaker 2

Now let me touch on the second half, which is off to a tough start. So far, through the 1st 3 weeks of Q3, our combined comp sales rate is down 6.5%. The themes of my business has been tough are the same we have identified already traffic, ticket and conversion. Despite the slow start to Q3, we remain relentlessly focused on 5 critical areas: 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.

Speaker 2

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 Q2 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.

Speaker 2

Peter?

Speaker 3

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 Quarter were $140,000,000 as compared to $144,600,000 in the Q2 of last year. Our sales in the Q2 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.

Speaker 3

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 percent in the Q2 of last year. This 180 basis point decrease was a combination of 100 10 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.

Speaker 3

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 3 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. 2nd, costs related to the fulfillment of direct to consumer orders continue to be elevated. And 3rd, the success of our new loyalty program means that there are more customers redeeming loyalty certificates for a discount on their purchase.

Speaker 3

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 and A expense as a percentage of sales decreased to 33.9% as compared to 34.2% in the prior year's Q2. On a dollar basis, SG and A expense decreased by $2,000,000 allowing us to improve by 30 basis points despite the lower sales.

Speaker 3

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 percent 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 percent and SG and A expense at 33.9 percent, this brings our adjusted EBITDA in at 16.4% or $22,900,000 for the 2nd 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.

Speaker 3

I want to spend a minute on one unusual transaction that occurred this quarter and will have some limited impact this later this year as well. We are taking advantage of a unique opportunity to strengthen our balance sheet and reduce P and 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 $1,600,000 to the plan And we recognized a non operating charge of $4,200,000 to flow the previously unrealized loss through the P and L.

Speaker 3

As of July 29, 2023, approximately 78% of the pension obligation has been paid, with the remaining 22% expected to be paid in the 4th quarter. At that time, we'll recognize the remaining charge, which we are at approximately $1,500,000 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 $62,800,000 as compared to $22,200,000 a year ago with no outstanding debt in either period and availability of $81,800,000 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 $21,600,000 for the 6 months to date.

Speaker 3

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 $10,800,000 to repurchase 2,200,000 shares at an average cost of $4.81 per share.

Speaker 3

At the end of the quarter, that left us with approximately $4,100,000 of our Board's original $15,000,000 authorization, which we have already fully utilized in the 1st 3 weeks of Q3. 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 2nd quarter results reflected a tax benefit of $35,100,000 which included the release of 35 point $5,000,000 or $0.53 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%.

Speaker 3

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 $78,900,000 in federal net operating loss carryforwards. Finally, I'll close with an update on our financial outlook for fiscal 2023, which we are training today in response Our updated guidance is for net sales of $535,000,000 to $545,000,000 and 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 6 months, we're at a year to date comp of negative 0.5 percent And we believe the 3rd quarter will be a mid single digit negative and the 4th quarter could claw back close to flat.

Speaker 3

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.

Speaker 2

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 3 to 5 years? I want to let you all know that we have 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 3 to 5 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.

Speaker 2

Over the past 2 years, we've essentially recapitalized the company. At the height of the pandemic, we were in heavy debt with no cash to speak up on the balance sheet, too much excess inventory and negative shareholder equity. Today, we have no debt, over $60,000,000 of cash and investments on the balance sheet And our shareholder equity is over $150,000,000 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 Thanks, Verience. 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.

Speaker 2

And during our most recent Board meeting, There was unanimous support in the belief that over the next 3 to 5 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 3 years to see our growth initiatives through.

Speaker 2

So let me get right into the 3 distinct priorities and opportunities that DXL is pursuing and which we believe can significantly raise the growth trajectory of this company in the next 3 to 5 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.

Speaker 2

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 center 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 We haven't rooted our messaging in a differentiated position and couldn't justify the brand spend.

Speaker 2

This on an absolute and consistent spending level. For the past several years, we 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.

Speaker 2

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 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.

Speaker 2

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 perception studies that have clearly led us to a Path that began with our trademark call to action, wear what you want or hashtag wwiw as we often refer to it. And now we have a better understanding of what motivates our different customers in different segments.

Speaker 2

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 $23,000,000,000 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 trade offs. We have already targeted a 10% adjusted EBITDA In the past in the last few years, we have achieved that milestone, but we were still not growing sales to a 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.

Speaker 2

We believe that over the next 3 to 5 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 margins that we have enjoyed over the past 2 years. We are faced with the prospect of being a $550,000,000 to $600,000,000 company at 12.5 percent EBITDA or Aiming higher and emerging over the next 3 to 5 years with for 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 3 new stores since 2018, one store will be in New York, one in Los Angeles and one store in Cincinnati.

Speaker 2

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 address is 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.

Speaker 2

In our most recent consumer research across 2,500 customers and non customers, 49% 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 6 conversions of casual mail XL stores to DXL and we expect to complete 4 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, we're working to evolve the customer experience in at least 4 additional existing DXL stores Before the end of 2023. The 3rd opportunity we see is through collaborations and retail alliances.

Speaker 2

We believe examples like UNTUCK IT are only the beginning and we are working in real time 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 And 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 more even more in the bull's eye 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 2 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.

Speaker 2

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 4 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 we've 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.

Operator

Thank you. Please standby while we compile the Q and A roster. Our first question comes from Michael Baker with D. A. Davidson.

Operator

Your line is open.

Speaker 4

Okay. Thanks, guys. So we love the New store growth, but also of the buybacks. It costs you less than $1,000,000 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.

Speaker 4

So just wondering, maybe this is a question for the Board, but the Board's appetite To or redo another buyback authorization and keep buying back stock here at the current levels?

Speaker 3

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.

Speaker 3

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 $15,000,000 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.

Speaker 4

Okay. But so I guess it 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.

Speaker 4

And I think with my math implies a much better 2nd 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 with business weakening a little bit, is there not markdown risk? 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.

Speaker 3

So there's 2 things that I guess I'll point to in the first half, which will We'll 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.

Speaker 2

And the other thing I'll jump on 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 probably heard elsewhere things like shorts and swim were a little difficult. But even with those difficult Seasonal businesses, what we said is our markdown rate was nearly at a historical low.

Speaker 2

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.

Speaker 4

Okay. If I could ask one more, I did want to ask about the loyalty program now, I guess not quite a year in, but 8 or 10 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?

Speaker 4

Are you making changes because it's not working out as well as you thought? Just if you could sort of talk about that? Thanks.

Speaker 2

Yes, it's a really it's Harvey. It's a really a bifurcated outcome. Quite honestly, the 2 best groups In the loyalty program in terms of tiers are the platinum and gold customer and honestly they're almost working 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 Then based on want is not participating as well as we would hope for.

Speaker 2

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 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 ticket, the whole point of the program is to create the 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.

Speaker 2

That's just how they're choosing to spend 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 reengage at a higher level of the lower tier customer and hopefully that helps you have some understanding.

Speaker 4

Yes, it really does. Thanks. I'll pass it on to someone else.

Operator

Thank you. One moment for our next question. We have a question from Jeremy Hamblin with Craig Hallum Capital Group. Your line is open.

Speaker 5

Thanks and congrats on the strong Q2 results. 1st, 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 average is 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?

Speaker 3

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 for some of those reasons I highlighted for on the previous question, We do expect some improvement in the second half of the year, yes.

Speaker 5

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 gave kind of certainly at least for FY 2024 and maybe FY 2020 5, we should be thinking about EBITDA margins that are under 10%. Did I hear that correctly?

Speaker 2

Yes. Conceptually, what we hope and envision is that we will invest in marketing. Part of that investment will be leveraged The P and L through greater sales and clearly at least on the onset part of that marketing will be SG and A increases And affect the P and L in the short term. Yes, 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.

Speaker 2

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.

Speaker 3

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, certainly 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.

Speaker 5

For sure. How in terms of That stuff always takes some time. I think that your advertising budget for this year is in the $30,000,000 to $35,000,000 range. So I think again just quick math here, you're looking at maybe a $15,000,000 to $20,000,000 increase for next year. Is there obviously, you need to Given 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 3 year period where you think Sales can be at x and is that x like $700,000,000 or can you give us a sense of what you think That incremental investment can result in?

Speaker 2

Yes, it's Harvey. The way we characterize 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 In very specific ways that are oriented around the positioning and the brand and that will take some time And it's not going to be more SEM digital marketing and hopefully you can kind of connect 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 engaging the consumer. So your reference without specifically giving a number Of $700,000,000 from a $550,000,000 base and change on multiple years stacked up 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 1 or 2 points. We would expect to be north of that And the digital business has historically operated between, let's say, 10% 15% growth rates for quite some time, Barring the pandemic challenges and volatility, we would expect to be north of that.

Speaker 2

So you have a comp base That is pretty significant, 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.

Speaker 5

Thanks. That's super helpful color and certainly Low double digit growth, that's for sure a growth company in retail.

Speaker 2

And Yes. The only other thing, Jeremy, I just want to caution you, as I said, without sharing competitive intelligence for LiveBear with that, 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 given the last 4 months of this year. So one would expect you'll see greater investment in 2024 And over 2024, 2025 sales ramped and then hopefully can continue to maintain that level Of increased low double digit performance.

Speaker 5

No, understood. Clearly, it doesn't happen overnight. I wanted to just get a little bit of color, 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, 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 Kind of your lease commitments and your real estate team are projecting in terms of thinking about how that might play out in 2024?

Speaker 3

Sure. So just a little color on that. As we mentioned, we've got the first three Our opening this fall, which we're really excited about, for the 10 next year, we have 7 that we've identified. We don't have leases signed yet, but We have 7 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 back loaded into 3rd and 4th quarter, there'll be some there, but I would expect maybe 4 in the first half, 6 in the second half, something like that.

Speaker 5

Got it. That is helpful color. All right, guys. I'll hop out of the queue, but congrats and best wishes.

Speaker 2

Thanks, Jeremy.

Operator

Thank you. Our next question will come from Raffi Savitz with RYS. Your line is open.

Speaker 6

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 the 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?

Speaker 2

Yes, Ravi, 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 that'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.

Speaker 2

So there is, 1st 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 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.

Speaker 2

They needed to go back to their doctor, get a prescription refill and their doctor wanted to chat with them before that. It took them 3 weeks and they gave £5 back. And I tell you all that because that's more catalyst for the unfortunate reality of going up and down. And our consumer, 1st of all, is big and tall. And if you're 6.5 and you're 2.80, you're not going to go to 6.5 and 180, it's unlikely you'll ever get below a big and tall size.

Speaker 2

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. For us as a business, we see it as a catalyst. We're hopeful that our consumer becomes healthier, loses weight and all those things, Which of course you would want, but in reality, the practical reality, he is not going to move out of big and tall in most cases. He's just going to really require new close for a loss in weight and potentially might require new close for a gain back of some of that.

Speaker 2

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.

Speaker 6

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 Kind of brand investments or any other investments you're kind of making in the business? And then just a 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?

Speaker 3

Sure. So I'll take the last one first. So cash taxes out for the next couple of years, it's going to depend on just where we come in with net income. But I do think This year will be very low cash taxes. Next year, we will be very low.

Speaker 3

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 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 $1 in capital in return, dollars 1.5 let's say, in sales is something that we're interested in doing.

Speaker 3

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.

Speaker 6

And on that note, in terms of the new stores, I guess, as you're thinking about, I guess, a few stores this year and then kind of Maybe 10 stores next year and more beyond that. I guess, how many of these leases do you expect to sign kind of near term versus Kind of waiting and seeing how, at least this cohort of new stores does before kind of going out and committing to a larger New development program.

Speaker 3

Yes. So as the number that we've been talking about is 50 new stores. And the cadence of getting those open, 3 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 will be a good year Before we have a real solid read on how the actual performance is, but 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.

Speaker 6

Got it. Thanks for the context guys.

Speaker 2

Thanks, Raffi. Hey, 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 year 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.

Speaker 2

So thanks much. Have a great early fall and we will talk to you in 90 short days.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

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Earnings Conference Call
Destination XL Group Q2 2024
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