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 session. [Operator Instructions] 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.

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 Kanter; and our Chief Financial Officer, Peter Stratton. During today's call, we will discuss some non-GAAP metrics to provide investors with useful information about our financial performance. Please refer to our earnings release, which was filed this morning and is available on our Investor Relations website at investor.dxl.com for an explanation and reconciliation of such measures. Today's discussion also contains certain forward-looking statements concerning the Company's sales and earnings guidance 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. Harvey?

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 our 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 eluting 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 our prepared remarks, will give you a sense of how we are thinking about greater growth and beginning to define our road map 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 our -- how we expect our comp sales results for…

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 in growth in our mobile app and e-mail 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 cost primarily due to the de-leveraging 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…

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 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 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 speak 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, understand his needs, understand his challenges and understand what makes him thick. 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.…

[Operator Instructions] Our first question comes from Michael Baker with D.A. Davidson. Your line is open.

Okay. Thanks, guys. So we love the new store growth, but also of the buybacks. It costs you less than $1 million, I think, to open a new store, seems like even if you do 10 or 20, you have plenty of cash left to continue to buy back stock. So just wondering, maybe this is a question for the Board, but the Board's appetite to ink or redo another buyback authorization and keep buying back stock here at the current levels?

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 plan. And 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 the times opportunistic. But for right now, we're mostly focused on getting the growth story going.

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. 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 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?

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.

The other thing I'll talk about is inventory. We are incredibly comfortable with our inventory is 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. So we are confident and comfortable with our inventory you may recall that we said last quarter, we would rather be chasing goods and 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. If I could ask one more, I did want to ask about the loyalty program now, I guess, not quite at year-end, 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? Are you making changes because it's not working out as well as you thought, just if you could sort of talk about that?

Yes. It's a really -- it's Harvey. It's really a 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, 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 it creates advocacy and an affinity and a greater relationship with us, but they come in and whether they use a $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 engaged 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 reengage at a higher level of the lower-tier customer. And hopefully, it helps you have some understanding.

Yes, it really does.

Thank you one moment for our next question. We have a question from Jeremy Hamblin with Craig-Hallum Capital Group.

Thanks and congrats on the strong Q2 results. First, I 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's projected in about 48.5% range. Is that correct?

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.

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 FY '24 and maybe FY '25, we should be thinking about EBITDA margins that are under 10%. Did I hear that correctly?

Yes. Conceptually, what we hope and envision is that we will invest in marketing. Part of that investment will be leveraged to the 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 other way to create 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.

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 will 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.

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 million to $35 million range. So, I think, again, just a quick math here. You're looking at maybe $15 million to $20 million increase for next year. 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 is that x is like $700 million Or can you give us a sense of what you think that incremental investment can result in?

Yes, 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 "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 engage in the consumer. So your reference without specifically giving a number of $700 million from a $550 million base in change on multiple years stack 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, 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 it 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.

That's super helpful color. And certainly, low double-digit growth that's for sure, a growth company in retail and…

The only other thing, Jeremy, I just want to caution you, as I said, without sharing competitive intelligence for [LIBOR] ways 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 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 continue to maintain that level of increased low double-digit performance.

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

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 back loaded into third and fourth quarter. There'll be some there. But I would expect maybe four in the first half, six in the second half, something like that.

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

Thanks Jeremy.

Our next question will come from Raphi Savitz with RYS.

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?

Yes, Raphi, 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 it's unfortunate because although those drugs are absolutely helping and we've heard about great stories, if you're 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 at 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 close. The other part that is interesting, and I'm not sure it's unfortunate it 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 needed 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 280, you're not going to go to 6.5 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 way back. So 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 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 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.

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?

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 would 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, we've got to wait until we get the movement, but at least going into it. We'll have an expectation. We also look real carefully at sales to invested capital. I think for a -- for us to be able to invest $1 in capital 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 25-plus IRR, we typically consider that a good capital investment. But again, it all comes back to -- 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.

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 -- your development program?

Yes. So as 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 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 their 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.

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 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.

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