Earnings Call Transcript - DXLG Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter 2020 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. Please be advised that today's call may be recorded. I will now hand the call over to Nitza McKee. Please go ahead.

Nitza McKee, President and Chief Executive Officer

Thank you, Michelle, and good morning, everyone. Thank you for joining us on Destination XL Group's Third Quarter Fiscal 2020 Earnings Call. On our call today is 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 now available on our Investor Relations website for an explanation and reconciliation of such measures. Today's discussion also contains certain forward-looking statements concerning the Company's ability to withstand the impact of the COVID-19 pandemic on its business and results in Fiscal 2020 and to manage through the pandemic, including its efforts to restructure and reduce costs, realize expected annualized savings from the restructuring actions taken in November, manage inventory, right size its lease structure, market to its customers to encourage shopping in-store and online and maintain sufficient liquidity to meet its working capital needs for the next 12 months. 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 factors that affect the company. Information regarding risk and uncertainties as 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?

Harvey Kanter, CEO

Thank you, Nitza, and good morning, everyone. I hope you're all healthy, safe, and well. I'm grateful for the opportunity to speak with you today about DXL and the progress we are making as we continue to navigate through the pandemic. For the past eight months, we have been pivoting and adjusting to withstand the unrelenting impact of the COVID-19 virus on all of us, and also on the economy as we strive to position DXL for the long-term recovery and for future growth. Most importantly, and before I begin any remarks in regards to our business, I want to make a few remarks in regards to our associates, and their tremendous level of commitment and sacrifice during these most challenging times. It has been nothing but quite remarkable. I have mentioned before about the element that most often keeps me up at night, and it's worth saying again, it is the team. Specifically, keeping the band together; that is the very foundation of a great business. We are incredibly proud of our associates in our stores, in our guest center, in our distribution center, and in our corporate office. The COVID-19 impact has been incredibly challenging and despite the deep commitment we had to our team and the culture at DXL, based on trust, empowerment, and innovation, the pandemic has also impacted many of these very same folks and their livelihood. The incredibly disruptive and challenging impact of COVID has left us no alternative but to reduce headcount and a number of associates are no longer a part of the DXL team. More broadly, as we know all too well, COVID has also resulted in many lives lost of loved ones who are no longer with us. The world is different in so many ways from what we knew only eight months ago. And as the CEO of DXL, and just as a human being, the challenges to navigate the virus' impact and the negative outcomes for our team and associates at DXL and the decisions we have had to make have been very difficult. And for that, I am very sorry. These days, there are many more things that keep me up at night, but the team we have and their commitment is not one of them. We have great people who are the backbone for cautious but continued optimism for the future of DXL. Now, specifically regarding our business today, I'm going to speak to you about our third quarter performance. I'm also going to update you on the steps we have taken and the steps currently underway to continue to position our financial recovery. But before I begin, I also want to comment on one other important topic: diversity and inclusion. At DXL, we continue to embrace efforts to combat the challenges of social unrest and racial divide. In 2017, we implemented our own awareness program, which we call 'normalizing the brand' to address unconscious bias. We have also this year formed a CEO Advisory Council, which meets every other month, and we also have ongoing training programs through our HR department to heighten awareness with our associates. We remain committed to not just being a part of the conversation, but a part of the solution. For today's call, I intend to cover three main topics: first, to review what we have accomplished in the third quarter; second, to discuss the state of our business as well as the current state of the industry; and finally, I will address what we define as the critical imperatives to win in this holiday season and into next year. So let's get started with a summary of our third quarter results. Our overall sales performance in the third quarter continued to be impacted by the pandemic. Comparable sales for the quarter were down 20.5% compared to last year, which is an improvement from the second quarter when our sales were down 38.6%. In the third quarter, store sales were down 31.5% while DXL.com was up 28.4%, with total direct sales up 18.2%. It is important to note that all of our stores were open by the end of June and our store performance has sequentially improved each month from June through September with improvements in both traffic and conversion. Overall, direct sales accounted for 33.4% of retail revenue. Our October sales momentum slowed by 600 basis points across the company as flare-ups from the virus began to resurge, fires on the West Coast occurred, and distractions from the election materialized. Our stores continued to lean into the priorities we set out back in May of 2020 as we adjusted our plans to the pandemic environment. First and foremost, ensuring a clean, healthy, and safe environment for our guests and for our associates. We've been working to drive the consumer back into the store through the following three-pronged approach: first, delivering a guest experience that has been our calling card by building relationships, not just sales, but also maintaining social distancing guidelines; second, perfecting the visual presentation within our stores such that each store can act as its own salesperson, further addressing social distancing as suggested by the CDC; and finally, enabling each store to act as its own fulfillment center for e-commerce orders. The importance of stores and their ability to support our e-commerce initiative is critical. Our most valuable customer is the cross-channel shopper who has shopped with us before. Our direct business, anchored by DXL.com, continued to grow throughout the third quarter. Our direct channel not only includes sales from DXL.com, but also sales from online marketplaces and sales initiated in stores that are fulfilled online via our universe technology. Lower traffic to stores has driven universe sales well below prior year levels. Universe sales originate in-store as our sales associates are trained to offer product extensions that may not be available in that particular store but are available on the web. Given the decline in store traffic, universe sales have been hit hard. In contrast, our direct fulfillment by stores remained materially higher during the third quarter. In the third quarter, our stores fulfilled $10.6 million worth of e-commerce demand, compared to only $5.7 million last year, an increase of 87.3% in the quarter. BOPAC and BOPUS continue to be momentum drivers and this is an area that we will continue to develop both in terms of functionality and user experience. We offer BOPAC and BOPUS in 311 stores. We will look to optimize this omnichannel experience over the coming months, taking a continued test and learn approach as we look to elevate the customer experience while driving increased digital penetration and shopper loyalty. DXL is positioned to continue benefiting from the shift online. We have a flexible off-mall store base, a large and growing platform digitally, and compelling and differentiated omnichannel capabilities, which reach not only our existing base of customers but also new consumers. Our omnichannel customer is five times more productive than a digital-only customer and three times more productive than a store-only customer. We were pleased to see a number of our store-only customers become omnichannel customers during this time. For the past three quarters, I've talked about how our focus on cash has been relentless. We are living and breathing with incredible attention to the smallest details to ensure we are managing our cash and maintaining liquidity. Every day, we are making decisions to provide the outcomes that will protect the long-term viability of our company, and occasionally, these decisions are some of the toughest. On November 2, we implemented an internal corporate restructuring to further realign our corporate selling, general, and administrative costs with our lower sales levels resulting from the pandemic. We eliminated 45 corporate positions, which we estimate will save $3.8 million on an annualized basis. We also eliminated certain service agreements, professional services, and certain marketing costs, which we estimate will save $5.2 million on an annualized basis. Combined, we estimate the restructuring will save $9.7 million in SG&A on an annualized basis. I would also like to point out that the actions implemented on November 2 are in addition to cost-saving actions that were already taken through the end of the third quarter. Inclusive of all the actions executed earlier this year, the company has now eliminated 101 positions from its corporate office, or 29% of its corporate workforce in the current fiscal year. Furthermore, since March 2020, the company's field personnel has been reduced by 1,078 positions, or 54% of the total field count. We continue to aggressively aim to drive our SG&A expenses down to be properly aligned with our expected sales and are managing to a downside case versus a more optimistic recovery. In addition to the above actions, we remain equally focused on right-sizing the company's occupancy costs. We have been very active with our landlords to communicate our challenges and strengthen our partnerships with the leasing community. As I mentioned last quarter, we are grateful that most of our landlords have been open to listening to us about the challenges presented by the COVID-19 pandemic and have been willing to assist us in managing cash flow and ultimately the occupancy costs of our retail stores. Now that we are past the initial surge of having stores closed in April, May, and part of June, we have turned our attention to our forward-looking rent structure. Over the quarter, we've performed yet again an exhaustive review of our lease portfolio, given the sales recovery or the reality of lack thereof at the levels we expected. We are now actively engaged with our landlord group to focus on stores where occupancy as a percent of sales has moved upwards and outside an acceptable band for market rents. One of the biggest risks of the company's business model is its predominantly fixed rent structure on a lower sales base. We are pushing hard to reduce lease costs with those landlords where our rents are out of line with sales. Now, let me shift to a quick update on our merchandising strategies. In the third quarter, casual sportswear and loungewear continued to drive the business while tailored clothing remained extremely challenging. In the past eight months, we observed a dramatic shift in consumer behavior that has focused on casual apparel and aligns with the work-from-home lifestyle. Comfort, functionality, and versatility are essential features expected from our customer and embedded in the key categories that will drive the business this season. We are seeing customers gravitate towards categories such as knits, shorts, activewear, denim, underwear, and athletic shoes. There is a heightened focus on these categories and on the brands that will meaningfully drive the business. We're also working on speeds of market initiatives, such as exploring vendor-managed inventory, or VMI, and we're working with factories to hold undyed materials for production, which provides greater flexibility in our inventory. Let me briefly touch on gross margins, promotions, and inventory. Peter will provide additional detail, but I am pleased to report that our third quarter gross margin, although below last year, was ahead of revised internal expectations. Back in the spring, specifically in April and May, we were running with a highly promotional posture. Our promotional offers were stronger than any we've offered in the last ten years. The purpose of that posture was to keep goods moving to customers and to keep cash coming into our company. For the third quarter, we became much more targeted with our promotions and saw a corresponding drop in our markdown rate. We have become increasingly oriented to specific consumer behaviors and consumer segments, finding greater opportunities to be less spread out with promotions and, as a result, driving promotions that positively impact gross margin dollars while eliminating promotions that drive sales with no or negative bottom line impact. We know we still have to be promotional, and while we expect to return to levels approximating last year over time, we believe we can outperform these historic rates. Regarding moving inventories, we have managed inventories very conservatively and are down just over 21% from last year's third quarter. We have been selling down our product and have slowed replenishment as we are being mindful of not overextending our assortment, which would require clearing out unsold merchandise in the off-season. It is also worth noting that we are working very hard to maintain our supply chain and logistics capabilities. One of the challenges we grappled with in the third quarter is securing vessels in a timely manner from overseas to receive product. There have been some disruptions in the global supply chain due to reasons ranging from COVID-19 outbreaks in foreign ports to shortages of vessels and shipping containers. Our fall receipts are down compared to last year, but in line with Q3 levels. It's actually been quite remarkable how we've seen certain brands and categories' performance sales levels nearly flat in some weeks, despite inventory levels that are down 40% to 50%. We continue to push inventory to our stores to satisfy customers who continue to shop in person. Due to our ship-from-store technology, we can fulfill direct orders from any store in the portfolio. Next, let me share some thoughts on our marketing and digital strategies. The biggest challenge facing DXL is our ability to drive meaningful traffic into our stores in the current environment. Secondly, continuing to drive growth in traffic onto our website remains significant. While we continue to make progress in acquiring new customers and reactivating old ones, successfully engaging our best customers, our highest-spending customers, continues to be a major challenge. We have identified and tested strategic and tactical actions in contact and communication changes to engage with our customers. However, the challenge remains significant and must be addressed to make meaningful strides. Our belief is that our best customers, who bought fashion and shopped for going out or just shopping, are no longer shopping the way they did. They are unfortunately going out less, if at all, have no weddings, no events, and are not visiting bars and restaurants, turning to fill in based on need rather than want. Our brands and private label assortments have always been quite fashionable, yet the occasions for wearing them are just not happening today. Our Q3 objective was to leverage consumer behavior by testing and learning with spend allocation, promotions, and other traffic-driving mechanisms to align with these changes. We've developed weekly reporting KPIs to better understand database health, customer sales trends. We've improved our email optimization for customer growth, including segmentation and technology updates on consumer preferences. Finally, we have tested direct mail promotions with a control group to better understand causation versus correlation for greater holiday success in omnichannel gross margin impact. The brick-and-mortar retail experience continues to be drastically different during the COVID-19 pandemic. Our store creed continues to be Engaged to Build A Relationship, or EBAR. We want to create a memorable experience while practicing social distancing by providing guests with the same in-store experience they've grown to love. We have also launched in test mode a new tool that allows store associates to interact virtually, but directly with online shoppers. It is an interactive platform that will bring our exceptional store experience to online customers by allowing in-store associates to connect live with online shoppers via a live video chat. The app provides online customers with a digital, in-store experience and allows store associates to earn commissions by creating sales. Store associates can suggest items based on the customer's wants and needs, as well as send pictures and videos of items in their stores to guests via chat on the app. We are currently running a 90-day pilot program with 40 stores and 100 associates. Based on the results of this test, we will consider how to augment this test and if this program warrants moving forward and can evolve further in important ways. Finally, let me provide you with an update on wholesale. We continue to pursue the wholesale business with our in-stock position with Amazon Essentials, but have experienced a slowdown in market demand for PPE. Amazon Essentials fit by DXL sales for Q3 came in at 71% compared to last year at $4.3 million. We continue to pursue this business to reduce stock outs, which peaked in August at 35.5% but have come down to 30% for the remainder of the quarter as additional inventory has been shipped. We have resumed the platforming of key fabrications to reduce our production lead times and partner with Amazon on an advanced replenishment model with visibility to future forecasting in key programs to secure fabrics and production capacity. Despite the challenges in-stock and losing some level sales, the business opportunity continues to be robust with greater potential. The launch in Q3 of the second brand new program, Goodthreads live by DXL, testifies to this. Goodthreads is Amazon's upscale private brand and differs from the core essentials brand, providing better fabrics and more fashionable options. This launch represents greater opportunity and potential for DXL's second brand for Big & Tall within Amazon's private brands program, which is exciting and further supports the opportunities ahead for both companies. I would now like to turn the call over to Peter for an update on the financials. Peter?

Peter Stratton, CFO

Thank you, Harvey, and good morning, everyone. I'd like to provide you with a summary of our third quarter financial results and then spend a few minutes highlighting some of the actions we have taken to protect the long-term viability of the company. We've started to see the results of those actions in our third quarter P&L, cash flow, and balance sheet. This gives me confidence that we are making the right decisions to get DXL through this pandemic and to emerge from this crisis well-positioned to continue serving Big & Tall guys across the country. With that said, let me give you an update on our third quarter financial results. Harvey already provided a comprehensive overview of our sales results, so I'm going to jump right into gross margin. Our gross margin rate, inclusive of occupancy costs, was 36.5% compared to a gross margin rate of 41.1% for the third quarter of fiscal 2019. This 460-basis point decrease in rate was comprised of a 280-basis point decrease in merchandise margins, and a 180-basis point deleveraging in occupancy costs against the lower sales base. Although down compared to last year, our gross margin rate showed significant improvement over the second quarter. We made progress in markdowns by focusing on more targeted promotions, and margin rates improved each month as the quarter progressed. Shipping costs continue to increase year-over-year due to growth in online sales and free shipping promotions. As I mentioned last quarter, our real estate team was successful in negotiating store rent abatements and deferrals from many of our landlords, which limited the deleveraging of our occupancy costs this quarter. However, as Harvey mentioned, the efforts to right-size our store occupancy costs to our new sales levels are still underway and we believe we can further close this gap. Now, let me move on to selling general and administrative expenses. For the third quarter of fiscal 2020, SG&A expenses were $32.8 million, or 38.5% of sales, versus the prior year's third quarter at $42.1 million, or 39.5% of sales. This $9.3 million year-over-year decrease is the result of the steps we took earlier this year, including adjusting store hours and staffing models to account for our new customer traffic patterns, significantly reducing marketing costs, especially through traditional non-digital channels, eliminating certain corporate positions, and reducing services, travel, and any discretionary spending. We continue to assess and rationalize our entire SG&A cost structure. As Harvey mentioned at the start of the call, we initiated corporate restructuring earlier this month, which we expect will save the company approximately $9.7 million annually. These were very difficult decisions, but we believe they were necessary to increase our financial flexibility and preserve our liquidity. During the third quarter, we recorded a $1.2 million non-cash gain primarily related to our decision to close two underperforming stores. Both of these stores had been underperforming for some time, and we had previously recorded an impairment charge on the right-of-use assets. In the third quarter, subsequent to the recognition of the impairment charges, we exercised our kickout rights to terminate the lease. The corresponding discharge of the remaining lease obligation created a $1.1 million non-cash gain, classified on our Q3 P&L statement as a reduction to the previously recorded impairment charges. The other $100,000 of gain was recorded as a reduction in store occupancy costs. This is the first time that we've recorded a non-cash gain due to the discharge of a lease obligation on a previously impaired right-of-use asset. However, such kickout rights exist in many of our store lease agreements. As we look to the next several years ahead of us, we may continue to exercise these kickout clauses from time to time in situations where occupancy costs are misaligned with sales performance. We have approximately 52 stores with kickouts or natural expirations coming due in Fiscal 2021, 44 stores in Fiscal 2022, and the remaining 220 stores in Fiscal 2023 and beyond. Adjusted EBITDA was negative $1.7 million for the third quarter, compared to positive $1.7 million for the third quarter of Fiscal 2019. The net loss for the third quarter was relatively flat with last year at negative $7 million, compared to negative $7.2 million, both at $0.14 per diluted share. Now, I'd like to move on to cash flow and the balance sheet. We have talked in the last two earnings calls about some of the immediate steps we took at the outset of this pandemic, including amending our credit facility to increase our borrowing base, decreasing our payroll, operating, and capital costs to align with the expected decrease in revenues, canceling purchase orders, negotiating extended payment terms with our merchandise vendors, and reaching agreements with our landlords to defer or abate rent. I'm pleased to report that our third quarter results demonstrate the effectiveness of these steps. For the first nine months of fiscal 2020, our free cash flow was a use of $11.6 million, compared to a use of $25.4 million for the first nine months of fiscal 2019. Due to the seasonality of our business and the build-up of inventory prior to the holiday selling season, it is typical for us to have a cash use in Q3. However, we were able to significantly reduce that impact this year by aligning our inventory purchases with expected sales levels, closely managing our expenses, vendor payment terms, and limiting our capital spending to only that which was necessary for our immediate business needs. This is a meaningful accomplishment and outcome given the situation at hand. Our capital expenditures for the first nine months of fiscal 2020 were $2.9 million, compared to $11 million for the same period last year. The spending was focused primarily on initiatives to drive growth in our direct-to-consumer business. We're pleased to report that we had a cash balance of $21.4 million at the end of the third quarter, a slight increase from the $20.4 million at the end of the second quarter. Our total debt, which is comprised of our revolving credit facility and FILO term loan, is $82.9 million. If we were to look at debt net of cash, our balance was $61.5 million at the end of the third quarter, compared to $77.5 million a year ago. We have $13.5 million of excess availability under our revolving credit facility, in addition to our cash on hand. Circling back to inventory for a moment, our inventory balance decreased by $25.3 million in the third quarter to $94.9 million, compared to $120.2 million a year ago; this decrease right-sized our inventory position for our fourth quarter sales forecasts and was accomplished primarily through the cancellation of orders earlier this year. We expect to end the year in a healthy inventory position with less merchandise than last year's end. As we place our inventory buys for fiscal 2021, we will respond to business changes, buying into categories that are trending upward and pulling back in categories that have slowed. This will allow us to narrow our assortment while continuing to manage clearance levels. Despite the challenges of the past few months, at the end of Q3, our clearance inventory levels were down $800,000 from a year ago and comprise 11.8% of our total inventory, just shy of our long-term goal of 10%. That's an accomplishment of which we are proud, especially in light of the reduction in our total inventory balance. As we continue to navigate through this pandemic, we will maintain a conservative approach to financial planning based on the assumption of slow improvement in sales trends in our stores, along with a continued acceleration in our direct business. We believe that the steps we've taken this year to preserve liquidity and maintain our financial flexibility represent important and significant steps toward our recovery. We look forward to the upcoming holiday shopping season and continue to serve our Big & Tall customers across all of our distribution channels. With that, I would like to turn it back over to Harvey for some closing thoughts.

Harvey Kanter, CEO

Thanks, Peter. As we focus on the balance of 2020 and look toward 2021, we are ever hopeful for the health of our nation and really humanity, for that vaccine being talked about to take hold quickly, and over time, we're even more hopeful for some return to normal, however that is defined for the future. And now, I just wish you all Godspeed and a happy and safe Thanksgiving. Operator, will now open it up to questions.

Operator, Operator

Thank you. Our first question comes from Eric Beder of SCC Research. Your line is open.

Eric Beder, Analyst

Good morning. Hi, I have a very near-term question. We've heard about Black Friday being not as important this year in terms of the actual day, trying to drive traffic early to get customers to shop before, or is it about the pandemic, or is it about shipping? How are you responding to that in the near term regarding your flow of promotions, in terms of getting people into the stores a little bit earlier?

Harvey Kanter, CEO

Yes, like everyone else, we have tried to appreciate that the biggest single challenge is that folks might not be comfortable coming into the stores to shop. Combined with the level of shipping that is happening in the world today, recognition that there will be challenges. We have started earlier with some of the initiatives we've done, such as our direct mail vehicle, which normally would arrive in-home on the Monday or Tuesday before Thanksgiving, but has already arrived as early as the 14th of the month. As of yesterday, we were at 83% in-home already. The promotion in that mailer creates two things as well: one, some level of promotion prior to Thanksgiving, which we communicated, and then an event for Black Friday if you will, followed by an event after Black Friday. So we've given the consumer a much greater runway to understand our offers, and what's available to them and when. That being said, our offers and mailers communicate different offers to different folks through segmentation. Ultimately, it is not overly promotional. It's certainly not more promotional than last year, because our experiences have demonstrated that customers are coming into the store on their terms. So far, we haven't been able to drive incremental traffic that is either incrementally profitable, and in some cases, profitable at all. So you won't see us being as promotional as people might anticipate, but time will tell.

Eric Beder, Analyst

On that vein, I've seen the return of some TV advertising. How does that fit into the overall DXL marketing universe?

Harvey Kanter, CEO

Yes, it's a great question. We believe that digital marketing is our core marketing lever, giving us the greatest ability to interact with our three core constituents: our current customers, the customers that lapsed, and customers that either don't know us or haven't shopped with us before. This can be accomplished through various digital means, such as email, display marketing, and specific search, both organic and paid. However, as consumers begin to buy gifts, there is an opportunity for us to drive further market share, and we are on TV more frequently now. We've started - I think our first TV campaign was specifically targeted during high-traffic events, such as NFL games, and have extended into other syndicated or current live TV shows during evening drive times. We focus on engaging customers who need to be reminded that we're still here, with a stronger focus on casual attire rather than tailored clothing in our advertisements.

Eric Beder, Analyst

Great. One last question; inventories. You've ramped up buy online pick up from store, you've ramped up ship from store. Both of these elements allow you to reduce your inventory holdings. Should we be thinking that the new permanent inventory levels will be lower when the world somewhat normalizes? How can you maximize inventory going forward?

Harvey Kanter, CEO

That's a great question. There are two inherent elements here. One is the nature of shopping behavior and dynamics of what is shifting, inherently a shift out of tailored clothing with suits, sport coats, dress slacks, and dress shoes, which turn meaningfully slower. Therefore, we are investing less in categories that turn slower, which helps create incremental turnovers. Additionally, we are trying to balance revenue maximization and the opportunity risks inherent in situations like COVID, managing how quickly the customer returns to stores. We are being cautious about placing receipts, but we don't want to be so conservative that we miss out on driving revenue. We expect a small improvement in customer turn, primarily driven by shifts in consumer behavior rather than not buying goods.

Eric Beder, Analyst

Good luck for the holiday season.

Harvey Kanter, CEO

Thanks so much, I appreciate the support.

Operator, Operator

Our next question comes from Bernard Sosnick of Madison Global. Your line is open.

Bernard Sosnick, Analyst

Thank you. Congratulations on maneuvering and adjusting so well. I'd like to get a little bit of coloration on sales in October and so far in November.

Harvey Kanter, CEO

As you might imagine, and I think has been widely published, we actually had what I would qualify—and I stress the word qualify—a good September. We measurably beat what we expected in September, which took us by surprise in a good way. Then, I would say equally so, October trailed off in an unexpected way; not materially from our expectations, but it wasn't as strong as September. That started in the beginning of October but definitely accelerated in the second half. The fires on the West Coast had an impact, as did the COVID flare-ups, and the unfortunate delays with the election. All of that conspired to make the end of October and the early weeks of November tough. However, interestingly, we've seen a significant change recently. We are hopeful that this change will continue as we approach Thanksgiving and Christmas. The magnitude of the change is not something that just occurs overnight. It's really a function of consumer volatility, and the world we live in today, with events like elections and fires and COVID. But to answer your question succinctly, October went backwards but we didn't completely deviate from our predictions.

Bernard Sosnick, Analyst

Thank you. That's very helpful. The other question I have is on accrued expenses. They're up around $3 million versus a year ago. What is the composition of that?

Peter Stratton, CFO

Sure. The accrued expenses, you're correct; last year they were about $25 million, this year about $28 million. It may pertain to some of the restructuring we did and long-term incentive accruals, but I can get back to you on that. It is up a couple of million dollars, primarily due to these factors.

Bernard Sosnick, Analyst

I was wondering whether or not where the adjustments and rentals show up. Because these would seem to be, in my mind, accrued liabilities for where there's been a deferral of rental.

Peter Stratton, CFO

Yes, you'll see those in the operating leases, which last year was $233 million, this year it's $196 million. All the adjustments to the leases are coming through that operating lease line on our balance sheet.

Bernard Sosnick, Analyst

But as you deferred rental payments during 2020, are some of those going to become due in 2021 as additional expense?

Peter Stratton, CFO

Well, they'll be due as additional cash. That's been part of our cash management strategy, and part of the reason we've maintained such a strong cash balance is that we haven't had to make those payments this year, but they are deferred to next year. They remain as accrued liabilities, but we were able to preserve cash this year.

Harvey Kanter, CEO

In terms of deferrals, just to clarify, our deferrals vary distinctly for every landlord. In some cases, the deferrals could have started to come back in the fourth quarter from the second quarter. They could be due in 2021. So there isn’t a “one-size-fits-all” approach to deferrals, as we have many unique arrangements with each landlord.

Bernard Sosnick, Analyst

I understand that. Your input is very helpful. Let me ask this. Given where you are right now in November, with the light switch having been turned on, assuming all things remain the same, what are the probabilities of you reaching your sales goals for the quarter?

Harvey Kanter, CEO

We feel good about our expectations. Our miss in October was not material; the biggest miss was the overachievement in September followed by going back in October. But relative to our expectations, October was fairly close. The recovery in November, we always knew that the election wouldn’t favor our sales. The first couple of weeks have been challenging, but over the last four days, we've seen a significant improvement compared to the earlier weeks. The question now is what will happen moving forward.

Bernard Sosnick, Analyst

Interesting. What are your targets regarding your ability to generate cash flow in the fourth quarter?

Peter Stratton, CFO

We feel confident about our ability to generate cash flow since this is our richest cash point of the year. Our stores are ready, our inventories are in good shape, and we're just awaiting how aggressively customers come into the stores and onto our website during this critically important holiday shopping season. So I would say, we feel very good about that.

Harvey Kanter, CEO

One thing you might not have caught is that with some of our best brands, our inventories are literally down 40% and 50%. We're chasing these brands extremely well. We have faced cancellations, and in some cases, we can't produce. But in certain weeks, we have been flat despite inventory reductions of 40% and 50%. As we chase more goods, that’s obviously a win. Couple that with our inventory levels, which will be lower than last year and a reduction of expenses and leases; with just a touch of sales momentum, we will create significant leverage.

Bernard Sosnick, Analyst

I did notice the 50% inventory reduction with flat sales, and I was curious if that would change your viewpoint on your overall inventory structure?

Harvey Kanter, CEO

Yes, our goal is certainly to refine our vendor base for 2021, which has almost been cut in half. Our team has curated a mix that has never been sharper. Our merchants have done a phenomenal job working closely with our key brands, such as Ralph Lauren, Vineyard Vines, and Psycho Bunny, ensuring that we steer the focus appropriately. We expect that with this curated mix and a specific intent to improve turnover, there is meaningful upside. Yet we are balancing that risk effectively.

Bernard Sosnick, Analyst

Finally, could you amplify a little on the Amazon relationship? It seems there’s a lot of potential looking forward.

Harvey Kanter, CEO

Yes, I completely agree. Amazon has been facing challenges similar to ours in understanding customer behaviors and how quickly they'll buy. Our Amazon Essentials program initially faced some challenges, but it rebounded strongly, creating a high level of out-of-stocks. While we are working hard to reduce out-of-stocks, the business is trending stronger than last year. Amazon has expressed a positive outlook on opportunities, and we have expanded our relationship to include the Goodthreads line, which showcases our second private brand with them. This collaboration addresses a different customer base than our core business, and we see it as a win-win.

Bernard Sosnick, Analyst

Thank you very much. Keep up everything you’re doing in a tough environment.

Harvey Kanter, CEO

Thanks so much. Have a safe and healthy holiday.

Operator, Operator

Our next question comes from Timothy Staples of Staples Asset Management. Your line is open.

Timothy Staples, Analyst

Considering the overall leverage of the company at the time the pandemic started, you've done a magnificent job preserving liquidity. You’ve maintained 12 months of liquidity and preserved optionality for shareholders. I want to congratulate you and frankly, as a shareholder, I am one of your biggest fans.

Harvey Kanter, CEO

Thank you.

Timothy Staples, Analyst

Setting that aside, I believe you mentioned during the previous conference call about the possibility of raising capital, but I wasn't clear on that. Can you talk about that and the relationship with your lenders? You mentioned 12 months of liquidity, which has remained stable since three months ago, good news. Can you speak to the broader aspects here?

Peter Stratton, CFO

Definitely. When the pandemic first hit, one of our top priorities was ensuring we leveraged our credit facility effectively. We modified our credit facility back in the spring, and we feel that our banks have been very supportive of DXL throughout this pandemic. Right now, there’s not much interest in pursuing equity financing, as we have a plan to get us through the next 12 months driven by strong working capital management. Our decline in debt, net of cash, illustrates that we believe our capital structure is relatively good now. The key remains watching sales, and while we can manage expenses, we need to keep a close eye on sales performance.

Timothy Staples, Analyst

Thank you for that answer. I’m excited about the operating leverage in the business, should those sales come through, and the ongoing monitoring of cash flow.

Harvey Kanter, CEO

I think the window is not materially different. We've been focused on the business, creating our future. Each of us will make decisions surrounding the company differently. I certainly was active in the market prior to this and expect to be again. Regarding your comment about optionality, we have been aggressive in ensuring decisions are made proactively rather than reactively. Our primary focus is giving ourselves options and resilience.

Timothy Staples, Analyst

Thank you. Congratulations again. In light of the challenges retailers are facing, your control over your destiny is a testament to your skills and the quality of your management team.

Harvey Kanter, CEO

Thank you very much. Operator, I think that's the end of the questioning today. I would just like to suggest everyone stay safe, stay home, wear your mask, and hug your loved ones. Thank you very much. Have a wonderful Thanksgiving.

Operator, Operator

Ladies and gentlemen, this concludes the conference. You may now disconnect. Everyone, have a great day.