Business context and reporting period
Destination XL Group, Inc. is a specialty retailer of big-and-tall men’s apparel, operating retail and direct businesses in one reported segment. The supplied filing is a Form 10-Q for the quarter ended August 2, 2014 (fiscal 2014 Q2), not 2013 Q2 as stated in the request metadata. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
At quarter-end, the company operated 354 stores: 113 Destination XL (DXL), 181 Casual Male XL retail, 51 Casual Male XL outlets and 9 Rochester Clothing stores. It was continuing its DXL expansion and winding down its Sears Canada business.
Financial results and key metrics
| Metric | Three months ended Aug. 2, 2014 | Three months ended Aug. 3, 2013 | Six months ended Aug. 2, 2014 | Six months ended Aug. 3, 2013 |
|---|---|---|---|---|
| Sales | $103.7 | $98.0 | $200.5 | $192.0 |
| Gross profit | $47.4 | $45.2 | $91.4 | $89.6 |
| Gross margin | 45.7% | 46.1% | 45.6% | 46.7% |
| Operating loss | $(3.5) | $(2.3) | $(6.6) | $(0.4) |
| Net loss | $(4.0) | $(1.6) | $(7.6) | $(0.6) |
| Diluted loss per share | $(0.08) | $(0.03) | $(0.16) | $(0.01) |
- Sales increased 5.8% in Q2 and 4.4% in the first half. Comparable sales rose 7.0% in Q2 and 5.2% in the first half. Q2 retail comps were up 8.5%; U.S. direct comps were up 0.5%.
- Q2 DXL comparable sales rose 11.3%; Casual Male XL and Rochester stores combined rose 7.1%. Direct sales remained affected by the prior-year catalog comparison, though management reported double-digit direct-sales growth in July.
- Q2 SG&A was $45.2 million, up $2.2 million year over year; first-half SG&A was $86.8 million, up $5.6 million. First-half depreciation and amortization rose to $11.1 million from $8.7 million. Net interest expense was $0.5 million for Q2 and $0.9 million for the first half.
- First-half operating cash flow was $(2.7) million, versus $5.7 million in the prior-year period. Capital expenditures were $18.9 million, producing reported non-GAAP free cash flow of $(21.6) million, versus $(15.4) million. Inventory increased to $116.0 million from $105.6 million at fiscal year-end; management cited inventory timing and mix.
- Cash was $5.6 million at August 2, 2014. Credit-facility borrowings were $25.7 million; equipment-note debt was $22.6 million, for approximately $48.3 million of these borrowings combined. The facility had $71.0 million of unused excess availability. Current liabilities were $95.5 million and current assets were $137.0 million.
- Stockholders’ equity declined to $99.4 million from $105.0 million at fiscal year-end, principally reflecting the first-half net loss.
Material changes versus the prior comparable period
- Despite higher sales, operating and net losses widened. First-half net loss increased to $7.6 million from $0.6 million.
- Q2 gross margin contracted 40 basis points and first-half gross margin contracted 110 basis points. Management attributed the decline mainly to promotions and markdowns supporting customer conversion and store traffic; lower occupancy costs partly offset the pressure.
- First-half operating cash flow shifted from positive $5.7 million to negative $2.7 million, while capital spending remained substantial. Inventory was a significant working-capital use.
- DXL store count rose to 113 from 65 a year earlier, while total store count fell to 354 from 388 as legacy stores were replaced or closed. The company opened 14 DXL stores in the first half.
- Q2 included $1.7 million of DXL transition costs and a $1.0 million Sears Canada operating loss. The Sears Canada loss included an approximately $0.8 million charge, primarily for inventory reserves and sales allowances, following the decision to exit that business.
- Comparative 2013 tailoring revenue and costs were reclassified from SG&A into sales and cost of goods sold; management said the reclassification did not change operating income.
Guidance, outlook, risks and unusual items
- Fiscal 2014 guidance was unchanged for GAAP diluted loss per share at $(0.21) to $(0.27); management gave non-GAAP diluted loss guidance of $(0.12) to $(0.16), assuming a normalized 40% tax benefit. The company expected to maintain a full valuation allowance and recognize no income-tax benefit for fiscal 2014.
- Management forecast sales of $413 million to $418 million, gross margin of 45.5% to 46.1%, and SG&A of $176.0 million to $177.6 million. It expected merchandise margin pressure from promotions, partly offset by improved occupancy costs as a percentage of sales.
- Fiscal 2014 capital expenditures were projected at $45.7 million, partly offset by $9.3 million in tenant allowances. Forecast operating cash flow was $11.6 million, including tenant allowances, and forecast non-GAAP free cash flow was $(34.1) million. Management revised these cash-flow expectations downward primarily because of planned early receipt of spring inventory.
- Year-end debt was forecast at $55 million to $60 million, with seasonal peak debt of approximately $75 million to $80 million. The company planned about 40 DXL openings for the full year, including five smaller-format stores, and expected to close approximately 39 Casual Male XL stores and one Rochester store.
- Management expected the later timing of fall advertising to weigh on Q3 sales comparisons but believed it would better support the holiday selling period. It cited severe winter weather as a factor in weak February and March results. The business is seasonal, with a significant share of operating income traditionally generated in Q4.
- Liquidity risks include continued operating losses, inventory and store-expansion funding needs, variable-rate credit-facility borrowings, and execution of the DXL strategy. Management said available cash and facility availability were sufficient for foreseeable needs under current forecasts. The facility matures June 26, 2018, is secured by company assets and has no financial covenants. A 50-basis-point rate increase was estimated to raise annualized interest expense by about $142,000.
- The company reported deferred tax assets of $73.9 million and a valuation allowance of $57.9 million. It also disclosed $3.2 million of unrecognized tax benefits related to a prior-year position concerning the exit from the European direct business. Management stated ordinary-course legal proceedings were not expected to have a material adverse effect; no material risk-factor changes were reported.
Important facts for investors to verify
- Confirm the reporting-period mismatch: the filing covers fiscal 2014 Q2 ended August 2, 2014, rather than 2013 Q2.
- Track whether comparable-sales growth, especially at DXL, converts into improved operating results after promotional spending and higher expansion costs.
- Monitor inventory levels, seasonal borrowing, credit-facility availability and delivery of the revised cash-flow and debt outlook.
- Assess progress and costs of the Sears Canada wind-down, expected in fiscal Q4, and the planned DXL openings and legacy-store closures.
- Review the full-year loss guidance, the non-GAAP adjustments and assumptions, and the continuing valuation allowance that prevents recognition of tax benefits.