Business Context and Reporting Period
Company: Designs, Inc. (Note: Metadata referenced "Destination XL Group, Inc.", but the filing text identifies the registrant as Designs, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 31, 1999
Business Overview: The Company operates retail stores in two primary segments: an Outlet Store Group (Levi's, Dockers, and Buffalo Jeans outlets) and a Specialty Store Group. The business is seasonal, with the second half of the fiscal year typically generating the majority of sales. The Company is currently undergoing a restructuring program involving the closure of unprofitable stores and a shift toward outlet operations.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended July 31, 1999 |
Three Months Ended Aug 1, 1998 |
Six Months Ended July 31, 1999 |
Six Months Ended Aug 1, 1998 |
|---|---|---|---|---|
| Sales | $42,907 | $47,078 | $82,742 | $90,478 |
| Gross Profit | $11,388 | $9,337 | $21,605 | $18,713 |
| Gross Margin % | 26.5% | 19.8% | 26.1% | 20.7% |
| Operating Loss | $(692) | $(5,168) | $(1,793) | $(10,229) |
| Net Loss | $(536) | $(3,094) | $(1,398) | $(6,146) |
| Loss Per Share (Basic/Diluted) | $(0.03) | $(0.20) | $(0.09) | $(0.39) |
| Cash and Equivalents | $1,868 | $1,079 | $1,868 | $1,079 |
| Short-term Restricted Investments | $2,300 | $0 | $2,300 | $0 |
| Total Debt (Notes Payable) | $24,168 | $4,626 | $24,168 | $4,626 |
| Working Capital | $19,451 | $40,474 | $19,451 | $40,474 |
Note: Working Capital calculated as Total Current Assets ($66,944) minus Total Current Liabilities ($47,493) for July 31, 1999, and Total Current Assets ($73,083) minus Total Current Liabilities ($32,609) for August 1, 1998.
Material Changes vs. Prior Period
- Profitability Improvement: Net loss decreased by 82.7% for the three months ended July 31, 1999, compared to the prior year period. For the six-month period, the net loss decreased by 77.3%. Management attributes this to expense reduction programs and the benefits of store closures.
- Gross Margin Expansion: Gross margin percentage increased significantly to 26.5% (Q2 1999) from 19.8% (Q2 1998). This was driven by a 4.2 percentage point improvement in occupancy costs as a percentage of sales and a 2.5 percentage point increase in merchandise margins.
- Debt Increase: Notes payable increased from $4.6 million to $24.2 million. This increase is primarily due to borrowings used to finance the acquisition of 25 outlet stores from Levi's Only Stores, Inc. in the prior fiscal year and to fund working capital needs.
- Sales Decline: Total sales declined 8.9% for the quarter and 8.6% for the six-month period. This was largely due to the closure of 34 stores, which reduced sales by $11.2 million (quarter) and $22.1 million (six months), partially offset by sales from new and remodeled stores.
- Comparable Store Sales: Comparable store sales declined 6.3% for the quarter and 2.3% for the six-month period. However, trends improved in August and early September 1999.
Guidance, Outlook, and Risks
- Restructuring Benefits: The Company expects the store closing charges taken in fiscal 1998 to yield combined earnings benefits of $8.5 million and cash flow benefits of $13.5 million for fiscal years 1999 and 2000.
- Capital Expenditures: The Company expects to incur approximately $2.6 million in capital expenditures for the remainder of fiscal 1999 for new stores, remodels, and system enhancements. Plans include relocating eight stores and opening three new outlet stores.
- Seasonality: The business is highly seasonal, with the "Fall" and "Holiday" seasons driving the majority of annual sales and operating income.
- Year 2000 Compliance: The Company anticipates completing Y2K conversion by the end of calendar year 1999 at a total cost of approximately $600,000. Risks include potential disruptions in data transmission from vendors, which could slow product shipments.
- Legal Proceedings:
- Boston Trading Litigation: Atlantic Harbor, Inc. sued the Company regarding a $1 million promissory note. The Company has counterclaimed for damages exceeding $1 million. Management does not believe the outcome will have a material adverse impact.
- Jewelcor Proposal: Jewelcor Management, Inc. submitted a proposal to acquire the Company for $3.65 per share. While the initial proposal was withdrawn in June 1999, Jewelcor filed a proxy statement in September 1999 to elect a new slate of directors and terminate the Shareholder Rights Agreement. Levi Strauss & Co. has indicated that a change in control via director election could violate the Outlet License Agreement.
- Liquidity: The Company relies on a $50 million revolving credit facility (with $23.2 million outstanding as of July 31, 1999) and cash flow from operations to fund working capital and expansion. The Company was in compliance with all debt covenants at the end of the period.
Investor Verification Checklist
- Debt Covenants: Verify continued compliance with tangible net worth and fixed charge coverage ratios under the $50 million credit facility, especially given the high debt load relative to equity.
- Store Closure Reserves: Monitor the utilization of the $3.4 million remaining reserve for store closings ($963k from Q3 FY98 charges and $2.4m from Q4 FY98 charges) to ensure actual costs do not exceed estimates.
- Control Change Risk: Assess the impact of the Jewelcor proxy fight and the potential violation of the Levi Strauss & Co. Outlet License Agreement if control is deemed to have transferred.
- Vendor Dependency: Evaluate the risk of supply chain disruption from Levi Strauss & Co. regarding Year 2000 compliance and the availability of branded merchandise.
- Comparable Sales Trend: Confirm if the positive comparable store sales trend observed in August and early September 1999 sustains through the critical holiday season.