DESTINATION XL GROUP, INC. - Quarter Report: 2017 October (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended October 28, 2017

OR

Commission File Number: 01-34219

DESTINATION XL GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (781) 828-9300

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 10, 2017, the registrant had 48,686,513 shares of common stock, $0.01 par value per share, outstanding.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

DESTINATION XL GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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DESTINATION XL GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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DESTINATION XL GROUP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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DESTINATION XL GROUP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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DESTINATION XL GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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DESTINATION XL GROUP, INC.

Notes to Consolidated Financial Statements

1. Basis of Presentation

In the opinion of management of Destination XL Group, Inc., a Delaware corporation (formerly known as Casual Male Retail Group, Inc. and, collectively with its subsidiaries, referred to as the “Company”), the accompanying unaudited consolidated financial statements contain all adjustments necessary for a fair presentation of the interim financial statements. These financial statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with the notes to the Company’s audited consolidated financial statements for the fiscal year ended January 28, 2017 included in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 20, 2017.

The information set forth in these statements may be subject to normal year-end adjustments. The information reflects all adjustments that, in the opinion of management, are necessary to present fairly the Company’s results of operations, financial position and cash flows for the periods indicated. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s business historically has been seasonal in nature, and the results of the interim periods presented are not necessarily indicative of the results to be expected for the full year.

The Company’s fiscal year is a 52- or 53- week period ending on the Saturday closest to January 31. Fiscal 2017 is a 53-week period ending on February 3, 2018 and fiscal 2016 was a 52-week period ending on January 28, 2017.

Segment Information

The Company reports its operations as one reportable segment, Big & Tall Men’s Apparel, which consists of two principal operating segments: its retail business and its direct business. The Company considers its operating segments to be similar in terms of economic characteristics, production processes and operations, and has therefore aggregated them into a single reporting segment, consistent with its omni-channel business approach. The direct operating segment includes the operating results and assets for LivingXL^® and ShoesXL^®.

Intangibles

At October 28, 2017, the “Casual Male” trademark had a carrying value of $0.4 million and is considered a definite-lived asset. The Company is amortizing the remaining carrying value on an accelerated basis, consistent with projected cash flows through fiscal 2018, its estimated remaining useful life.

The Company’s “Rochester” trademark is considered an indefinite-lived intangible asset and has a carrying value of $1.5 million. During the nine months ended October 28, 2017, no event or circumstance occurred which would cause a reduction in the fair value of the Company’s reporting units, requiring interim testing of the Company’s “Rochester” trademark.

Fair Value of Financial Instruments

ASC Topic 825, Financial Instruments, requires disclosure of the fair value of certain financial instruments. ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements.

The valuation techniques utilized are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of assets or liabilities.

The Company utilizes observable market inputs (quoted market prices) when measuring fair value whenever possible.

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The fair value of long-term debt is classified within Level 2 of the valuation hierarchy. At October 28, 2017, the fair value approximated the carrying amount based upon terms available to the Company for borrowings with similar arrangements and remaining maturities.

The fair value of indefinite-lived assets, which consists of the Company’s “Rochester” trademark, is measured on a non-recurring basis in connection with the Company’s annual impairment test. The fair value of the trademark is determined using a projected discounted cash flow analysis based on unobservable inputs and is classified within Level 3 of the valuation hierarchy. See Intangibles above.

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and short-term borrowings approximate fair value because of the short maturity of these instruments.

Accumulated Other Comprehensive Income (Loss) - (“AOCI”)

Other comprehensive income (loss) includes amounts related to foreign currency and pension plans and is reported in the Consolidated Statements of Comprehensive Income (Loss). Other comprehensive income and reclassifications from AOCI for the three and nine months ended October 28, 2017 and October 29, 2016, respectively, were as follows:

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Revenue Recognition

Revenue from the Company’s retail business is recorded upon purchase of merchandise by customers, net of an allowance for sales returns. Revenue from the Company’s direct business is recognized at the time a customer order is delivered, net of an allowance for sales returns. Store sales are defined as sales that originate and are fulfilled directly at the store level.  E-commerce sales are defined as sales that originate online, including those initiated online at the store level.  

Stock-based Compensation

All share-based payments, including grants of employee stock options and restricted stock, are recognized as an expense in the Consolidated Statements of Operations based on their fair values and vesting periods. The fair value of stock options is determined using the Black-Scholes valuation model and requires the input of subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (the “expected term”), the estimated volatility of the Company’s common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). The Company reviews its valuation assumptions at each grant date and, as a result, is likely to change its valuation assumptions used to value employee stock-based awards granted in future periods. The values derived from using the Black-Scholes model are recognized as an expense over the vesting period, net of estimated forfeitures. The estimation of stock-based awards that will ultimately vest requires significant judgment. Actual results and future changes in estimates may differ from the Company’s current estimates.

Impairment of Long-Lived Assets

The Company reviews its long-lived assets for events or changes in circumstances that might indicate the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of the assets by determining whether the carrying value of such assets over their respective remaining lives can be recovered through projected undiscounted future cash flows. The amount of impairment, if any, is measured based on projected discounted future cash flows using a discount rate reflecting the Company’s average cost of funds.

In the second quarter of fiscal 2017, the Company recorded an impairment charge of $1.7 million for the write-down of property and equipment.  The impairment charge related to a store where the carrying value exceeded fair value.  The fair value of these assets, based on Level 3 inputs, was determined using estimated discounted cash flows.  The impairment charge was included in Depreciation and Amortization on the Consolidated Statement of Operations for the nine months ended October 28, 2017.  There was no material impairment of assets in the third quarter of fiscal 2017 or in the first nine months of fiscal 2016.

Recently Adopted Accounting Pronouncements

In July 2015, the FASB issued ASU 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory," which applies to inventory that is measured using first-in, first-out ("FIFO") or average cost. Under the updated guidance, an entity should measure inventory that is within scope at the lower of cost and net realizable value, which is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This ASU is effective for annual and interim periods beginning after December 15, 2016, with early adoption permitted.  The Company adopted this pronouncement as of January 29, 2017.  The adoption of this standard did not have a material impact on the Company’s Consolidated Financial Statements.

In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards, and classification on the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company adopted this standard during the first quarter of fiscal 2017. The adoption of this standard did not have a material impact on the Company’s provision for income taxes or diluted earnings per share.  The Company has elected to adopt the guidance related to the presentation of excess tax benefits in its Consolidated Statements of Cash Flows on a prospective transition method.  Since there were no excess tax benefits for the nine months ended October 28, 2017 or October 29, 2016, this election did not result in a change in presentation on the Consolidated Statement of Cash Flows.  In addition, the Company has elected to continue to estimate forfeitures at each grant.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition,” as well as various other sections of the ASC, such as, but not limited to, ASC 340-20, “Other Assets and Deferred Costs - Capitalized Advertising Costs”. The core principle of ASU 2014-09 is that an entity should recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and is to be applied either retrospectively to each prior reporting period presented or with the cumulative effect recognized at the date of initial adoption as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets on the balance sheet). Early adoption is

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permitted after December 15, 2016. The Company expects to adopt ASU 2014-09 in the first quarter of fiscal 2018, using the modified retrospective approach as a transition method.   The Company is continuing to evaluate the impact that ASU 2014-09 will have on its Consolidated Financial Statements and its disclosures, particularly as it relates to the Company’s revenue recognition policies and internal controls for gift card breakage, loyalty award program and estimates for sales returns.  Based on these efforts, the Company currently anticipates that the performance obligations underlying its core revenue stream and the timing of recognition therefore, will remain substantially unchanged.  The Company expects that ASU 2014-09 will require additional disclosure, but does not expect the adoption to have a material impact on its Consolidated Financial Statements.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which will require an entity to recognize lease assets and lease liabilities on its balance sheet and will increase disclosure requirements on its leasing arrangements.  The ASU is effective for annual periods beginning after December 15, 2018, and interim periods therein.  Early adoption is permitted. In the financial statements in which the ASU is first applied, leases shall be measured and recognized at the beginning of the earliest comparative period presented with an adjustment to equity. While the Company is still evaluating the impact this pronouncement will have on its Consolidated Financial Statements, the Company expects a gross-up of its Consolidated Balance Sheets as a result of recognizing lease liabilities and right of use assets.  The extent of such gross-up is under evaluation.  

In March 2016, the FASB issued ASU 2016-04, “Liabilities—Extinguishments of Liabilities: Recognition of Breakage for Certain Prepaid Stored-Value Products,” which amends exempting gift cards and other prepaid stored-value products from the guidance on extinguishing financial liabilities. Rather, they will be subject to breakage accounting consistent with the new revenue guidance in Topic 606. However, the exemption only applies to breakage liabilities that are not subject to unclaimed property laws or that are attached to segregated bank accounts (e.g., consumer debit cards).  The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of this pronouncement to have a material impact on its Consolidated Financial Statements.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which reduces the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230.  The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  The Company does not expect the adoption of this pronouncement to have a material impact on its Consolidated Financial Statements.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfer of Assets Other Than Inventory,” which reduces the existing diversity in practice in how income tax consequences of an intra-entity transfer of an asset other than inventory should be recognized. The amendments in ASU 2016-16 require an entity to recognize such income tax consequences when the intra-entity transfer occurs rather than waiting until such time as the asset has been sold to an outside party.  The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  The Company does not expect the adoption of this pronouncement to have a material impact on its Consolidated Financial Statements.

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718)”which provides clarity in order to reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  Early adoption is permitted. The Company does not expect the adoption of this pronouncement to have a material impact on its Consolidated Financial Statements.

No other new accounting pronouncements, issued or effective during the first nine months of fiscal 2017, have had or are expected to have a significant impact on the Company’s Consolidated Financial Statements.

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2. Debt

Credit Agreement with Bank of America, N.A.

On October 30, 2014, the Company amended its credit facility with Bank of America, N.A, effective October 29, 2014, by executing the Second Amendment to the Sixth Amended and Restated Loan and Security Agreement (as amended, the “Credit Facility”).

The Credit Facility provides for maximum committed borrowings of $125 million. The Credit Facility includes, pursuant to an accordion feature, the ability to increase the Credit Facility by an additional $50 million upon the request of the Company and the agreement of the lender(s) participating in the increase. The Credit Facility includes a sublimit of $20 million for commercial and standby letters of credit and a sublimit of up to $15 million for swingline loans. The Company’s ability to borrow under the Credit Facility is determined using an availability formula based on eligible assets. The maturity date of the Credit Facility is October 29, 2019. The Company’s obligations under the Credit Facility are secured by a lien on substantially all of its assets, excluding (i) a first priority lien held by the lenders of the Term Loan Facility on certain equipment of the Company described below and (ii) intellectual property.

At October 28, 2017, the Company had outstanding borrowings under the Credit Facility of $68.4 million, before unamortized debt issuance costs of $0.2 million. Outstanding standby letters of credit were $3.3 million and outstanding documentary letters of credit were $0.1 million. Unused excess availability at October 28, 2017 was $38.2 million. Average monthly borrowings outstanding under the Credit Facility during the first nine months of fiscal 2017 were $60.4 million, resulting in an average unused excess availability of approximately $43.3 million. The Company’s ability to borrow under the Credit Facility is determined using an availability formula based on eligible assets, with increased advance rates based on seasonality.  Pursuant to the terms of the Credit Facility, if the Company’s excess availability under the Credit Facility fails to be equal to or greater than the greater of (i) 10% of the Loan Cap (defined in the Credit Facility as the lesser of the revolving credit commitments at such time or the borrowing base at the relevant measurement time) and (ii) $7.5 million, the Company will be required to maintain a minimum consolidated fixed charge coverage ratio of 1.0:1.0 in order to pursue certain transactions, including but not limited to, stock repurchases, payment of dividends and business acquisitions.

Borrowings made pursuant to the Credit Facility will bear interest at a rate equal to the base rate (determined as the highest of (a) Bank of America N.A.’s prime rate, (b) the Federal Funds rate plus 0.50% or (c) the annual ICE-LIBOR rate (“LIBOR”) for the respective interest period) plus a varying percentage, based on the Company’s borrowing base, of 0.50%-0.75% for prime-based borrowings and 1.50%-1.75% for LIBOR-based borrowings. The Company is also subject to an unused line fee of 0.25%. At October 28, 2017, the Company’s prime-based interest rate was 4.75%. At October 28, 2017, the Company had approximately $64.0 million of its outstanding borrowings in LIBOR-based contracts with an interest rate of 2.70%. The LIBOR-based contracts expired on October 31, 2017. When a LIBOR-based borrowing expires, the borrowings revert back to prime-based borrowings unless the Company enters into a new LIBOR-based borrowing arrangement.

The fair value of the amount outstanding under the Credit Facility at October 28, 2017 approximated the carrying value.

Long-Term Debt

Components of long-term debt are as follows:

Equipment Financing Loans

Pursuant to a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC, dated July 20, 2007 and amended on September 30, 2013 (the “Master Agreement”), the Company entered into twelve equipment security notes between September 2013 and June 2014 (in aggregate, the “Notes”), whereby the Company borrowed an aggregate of $26.4 million. The Notes are for a term of 48 months and accrue interest at fixed rates ranging from 3.07% to 3.50%. Principal and interest are paid monthly, in arrears.

The Notes are secured by a security interest in all of the Company’s rights, title and interest in and to certain equipment. The Company was subject to prepayment penalties through the second anniversary of each note.  The Company is no longer subject to any

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prepayment penalties. The Master Agreement includes default provisions that are customary for financings of this type and are similar and no more restrictive than the Company’s existing Credit Facility.

Term Loan

On October 30, 2014, the Company entered into a term loan agreement with respect to a new $15 million senior secured term loan facility with Wells Fargo Bank, National Association as administrative and collateral agent (the “Term Loan Facility”). The effective date of the Term Loan Facility is October 29, 2014 (the “Effective Date”). The proceeds from the Term Loan Facility were used to repay borrowings under the Credit Facility.

The Term Loan Facility bears interest at a rate per annum equal to the greater of (a) 1.00% and (b) the one month LIBOR rate, plus 6.50%.  Interest payments are payable on the first business day of each calendar month, and increase by 2% following the occurrence and during the continuance of an “event of default,” as defined in the Term Loan Facility. The Term Loan Facility provides for quarterly principal payments on the first business day of each calendar quarter, which commenced the first business day of January 2015, in an aggregate principal amount equal to $250,000, subject to adjustment, with the balance payable on the termination date.

The Term Loan Facility includes usual and customary mandatory prepayment provisions for transactions of this type that are triggered by the occurrence of certain events.  In addition, the amounts advanced under the Term Loan Facility can be optionally prepaid in whole or part without penalty.    

The Term Loan Facility matures on October 29, 2019. It is secured by a first priority lien on certain equipment of the Company, and a second priority lien on substantially all of the remaining assets of the Company, excluding intellectual property.

3. Long-Term Incentive Plans

The following is a summary of the Company’s long-term incentive plans.  Beginning on August 4, 2016, all equity awards granted under long-term incentive plans are issued from the Company’s stockholder-approved 2016 Incentive Compensation Plan.  All prior awards were issued from the Company’s 2006 Incentive Compensation Plan, which expired on July 31, 2016.  See Note 4, Stock-Based Compensation.

2016 Long-Term Incentive Wrap-Around Plan

The 2016 Long-Term Incentive Wrap-Around Plan (the “Wrap-Around Plan”), which was approved in the fourth quarter of fiscal 2014, was a supplemental performance-based incentive plan that was only effective if there was no vesting of the performance-based awards under the 2013-2016 LTIP and, as a result, all performance-based awards under that plan are forfeited.  The performance targets under the 2013-2016 LTIP were not achieved at the end of fiscal 2016 and accordingly, the Wrap-Around Plan became effective.

The performance target under the Wrap-Around Plan consisted of two metrics, Sales and EBITDA, with threshold (50%), target (80%) and maximum (100%) payout levels.  Each metric was weighted as 50% of the total performance target.  However, in order for there to be any payout under either metric, EBITDA for fiscal 2016 had to be equal to or greater than the minimum threshold.    

The Wrap-Around Plan also provided for an opportunity to receive additional shares of restricted stock if the performance targets were achieved and the Company’s closing stock price was $6.75 or higher on the day earnings for fiscal 2016 were publicly released, which was March 20, 2017.  The stock did not achieve a minimum of $6.75, therefore, no additional award was earned.

Based on the operating results for fiscal 2016, the Company achieved a 50.6% payout of its EBITDA target.  The minimum threshold for the Sales target was not achieved.  Accordingly, subsequent to year-end, in the first quarter of fiscal 2017, the Compensation Committee of the Board of Directors approved awards totaling $2.3 million, with a grant date of March 20, 2017.  On that date, the Company granted shares of restricted stock, with a fair value of approximately $1.0 million and cash awards totaling approximately $1.3 million.  All awards vested on July 28, 2017.  

On March 20, 2017, in conjunction with the grant of restricted stock awards, the Company reclassified $0.9 million of the liability accrual from “Accrued Expenses and Other Current Liabilities” to “Additional Paid-In Capital.” See the Consolidated Statement of Changes in Stockholders’ Equity.

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New Long-Term Incentive Plan

With the 2013-2016 LTIP and Wrap-Around Plan expiring at the end of fiscal 2016, on March 15, 2016, the Compensation Committee approved the Destination XL Group, Inc. Long-Term Incentive Plan, as amended February 1, 2017 (the “new LTIP”).

Under the terms of the new LTIP, each year the Compensation Committee will establish performance targets which will cover a two-year performance period (each a “Performance Period”), thereby creating overlapping Performance Periods.  Each participant in the plan will be entitled to receive an award based on that participant’s “Target Cash Value” which is defined as the participant’s annual base salary (on the participant’s effective date) multiplied by his or her long-term incentive program percentage, which is 100% for the Company’s Chief Executive Officer, 70% for its senior executives and 25% for other participants in the plan.  Because of the overlapping two-year Performance Periods, the Target Cash Value for any award is based on one year of annual salary, as opposed to two years, to avoid doubling an award payout in any given fiscal year.

For each participant, 50% of the Target Cash Value is subject to time-based vesting and 50% is subject to performance-based vesting.  The time-vested portion of the award will vest in two installments with 50% of the time-vested portion vesting on April 1 following the fiscal year end which marks the end of the applicable Performance Period and 50% vesting on April 1 the succeeding year. The performance-based vesting is subject to the achievement of the performance target(s) for the applicable Performance Period. Performance awards granted will vest on August 31 following the end of the applicable Performance Period.  

For the 2016-2017 Performance Period, the Compensation Committee established two performance targets under the LTIP (the “2016-2017 LTIP”), each weighted 50%. The first target is EBITDA for fiscal 2017, defined as earnings before interest, taxes, depreciation and amortization, and the second target is “DXL Comparable Store Marginal Cash-Over-Cash Return”, defined as the aggregate of each comparable DXL store’s four-wall cash flow for fiscal 2017 divided by the aggregate capital investment, net of any tenant allowance, for each comparable DXL store.  

For the 2017-2018 Performance Period, the Compensation Committee established two performance targets under the LTIP (the “2017-2018 LTIP”), each weighted 50%.  The first target is Total Company Comparable Sales and will be measured based on a two-year stack, which is the sum of the Total Company Comparable Sales for fiscal 2017 and fiscal 2018.  The second target is a Modified ROIC, which is defined as Operating Income divided by Invested Capital (Total Debt plus Stockholders’ Equity).

All awards granted under both the 2016-2017 LTIP and 2017-2018 LTIP were in restricted stock units (RSUs). Assuming that the Company achieves the performance target at target levels and all time-vested awards vest, the compensation expense associated with the 2016-2017 LTIP and 2017-2018 LTIP is estimated to be approximately $4.0 million and $4.2 million, respectively.  Approximately half of the compensation expense for each plan relates to the time-vested RSUs, which are being expensed over thirty-six months, based on the respective vesting dates. With respect to the performance-based component, RSUs will be granted at the end of the performance period if the performance targets are achieved. Through the end of the third quarter of fiscal 2017, the Company had accrued approximately $0.3 million in compensation expense related to the potential payout of performance awards under the 2016-2017 LTIP. No accrual has been made for performance awards under the 2017-2018 LTIP.  

4. Stock-Based Compensation

Through the end of the second quarter of fiscal 2016, the Company’s 2006 Incentive Compensation Plan (as amended and restated effective as of August 1, 2013, the “2006 Plan”) was the only stockholder-approved plan. The 2006 Plan expired on July 31, 2016. In the third quarter of fiscal 2016, at the Company’s 2016 Annual Meeting of Stockholders held August 4, 2016, the Company’s stockholders approved the adoption of the 2016 Incentive Compensation Plan (the “2016 Plan”).

2016 Plan

The initial share reserve under the 2016 Plan, including the rollover of 525,538 available shares under our 2006 Plan was 5,725,538 shares of our common stock. A grant of a stock option award or stock appreciation right will reduce the outstanding reserve on a one-for-one basis, meaning one share for every share granted.  A grant of a full-value award, including, but not limited to, restricted stock, restricted stock units and deferred stock, will reduce the outstanding reserve by a fixed ratio of 1.9 shares for every share granted.  In accordance with the terms of the 2016 Plan, any shares outstanding under the 2006 Plan at August 4, 2016 that subsequently terminate, expire or are canceled for any reason without having been exercised or paid are added back and become available for issuance under the 2016 Plan, with options and stock appreciation rights being added back on a one-for-one basis and full-value awards being added back on a 1 to 1.9 basis. At October 28, 2017, the Company had 6,437,283 shares available under the 2016 Plan.

The 2016 Plan is administered by the Compensation Committee. The Compensation Committee is authorized to make all determinations with respect to amounts and conditions covering awards.  Options are not granted at a price less than fair value on the date of the grant. Except with respect to 5% of the shares available for awards under the 2016 Plan, no award will become exercisable unless such award has been outstanding for a minimum period of one year from its date of grant.

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The following tables summarize the share activity and stock option activity for the Company’s 2006 Plan and 2016 Plan, on a combined basis, for the first nine months of fiscal 2017:

Valuation Assumptions

For the first nine months of fiscal 2017, the Company granted 30,000 stock options, 484,558 shares of restricted stock, 804,701 RSUs and 74,968 shares of deferred stock. For the first nine months of fiscal 2016, the Company granted 8,522 stock options, 3,834 shares of restricted stock, 431,270 RSUs and 23,570 shares of deferred stock.

Unless otherwise specified by the Compensation Committee, RSUs, restricted stock and deferred stock are valued using the closing price of the Company’s common stock on the day immediately preceding the date of grant.

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model.  The following assumptions were used for grants for the first nine months of fiscal 2017 and fiscal 2016:

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Non-Employee Director Compensation Plan

The Company granted 29,425 shares of common stock, with a fair value of approximately $71,454, to certain of its non-employee directors as compensation in lieu of cash in the first nine months of fiscal 2017.

Stock Compensation Expense

The Company recognized total stock-based compensation expense of $1.3 million and $1.1 million for the first nine months of fiscal 2017 and fiscal 2016, respectively.   The total compensation cost related to time-vested stock options, restricted stock and RSU awards not yet recognized as of October 28, 2017 was approximately $2.4 million, net of estimated forfeitures, which will be expensed over a weighted average remaining life of 22 months.  

5. Earnings per Share

The following table provides a reconciliation of the number of shares outstanding for basic and diluted earnings per share:

The following potential common stock equivalents were excluded from the computation of diluted earnings per share in each period because the exercise price of such options was greater than the average market price per share of common stock for the respective periods or because of the unearned compensation associated with either stock options, restricted stock units, restricted or deferred stock had an anti-dilutive effect.

The above options, which were outstanding at October 28, 2017, expire from June 8, 2018 to August 31, 2027 .

There were no performance-based awards outstanding at October 28, 2017. For the third quarter and first nine months of fiscal 2016, 893,621 shares of unvested performance-based restricted stock and 1,125,317 performance-based stock options were excluded from the Company’s computation of basic and diluted earnings per share. All outstanding performance-based awards expired unvested in March 2017 as a result of the Company’s not achieving performance targets in fiscal 2016.  

Shares of unvested time-based restricted stock of 53,333 at October 28, 2017 and 356,227 shares at October 29, 2016 were excluded from the computation of basic earnings per share and will continue to be excluded until such shares vest. See Note 3, Long-Term Incentive Plans, for a discussion of the Company’s LTIP plans and equity awards.

All 53,333 shares of restricted stock outstanding at October 28, 2017 are considered issued and outstanding. Each share of restricted stock has all of the rights of a holder of the Company’s common stock, including, but not limited to, the right to vote and the right to receive dividends, which rights are forfeited if the restricted stock is forfeited.

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6. Stock Repurchase Plan

On March 17, 2017, the Company’s Board of Directors approved a stock repurchase plan. Under the stock repurchase plan, the Company may purchase up to $12.0 million of its common stock through open market and privately negotiated transactions during fiscal 2017.  The timing and the amount of any repurchases of common stock will be determined based on the Company’s evaluation of market conditions and other factors. The stock repurchase program commenced in the first quarter of fiscal 2017 and will expire on February 3, 2018, but may be suspended, terminated or modified at any time for any reason.  The Company expects to finance the repurchases from operating funds and/or periodic borrowings on its Credit Facility.  Any repurchased common stock will be held as treasury stock and will be recorded on a trade-date basis.

Through October 28, 2017, the Company purchased 1,878,434 shares of common stock at an average price of $2.49 per share.  Approximately $7.3 million remains available under the stock repurchase plan. There were no stock repurchases during the third quarter of fiscal 2017.

7. Income Taxes

At October 28, 2017, the Company had total deferred tax assets of approximately $84.4 million, total deferred tax liabilities of $12.6 million and a corresponding valuation allowance of $72.0 million.

In the fourth quarter of fiscal 2013, the Company entered into a three-year cumulative loss position and based on forecasts at that time, the Company expected the cumulative three-year loss to increase as of the end of fiscal 2014. Management determined that this represented significant negative evidence at February 1, 2014. While the Company has projected it will return to profitability, generate taxable income and ultimately emerge from a three-year cumulative loss, based on a consideration of all positive and negative evidence as of February 1, 2014, the Company established a full allowance against its net deferred tax assets. Based on the Company’s forecast for fiscal 2017, the Company believes that a full allowance remains appropriate at this time.

As of October 28, 2017, the Company had net operating loss carryforwards of $155.9 million for federal income tax purposes and $88.8 million for state income tax purposes that are available to offset future taxable income through fiscal year 2037. Additionally, the Company has alternative minimum tax credit carryforwards of $2.3 million, which are available to further reduce income taxes over an indefinite period. Additionally, the Company has $2.6 million of net operating loss for tax purposes related to the Company’s operations in Canada.

The utilization of net operating loss carryforwards and the realization of tax benefits in future years depends predominantly upon having taxable income. Under the provisions of the Internal Revenue Code, certain substantial changes in the Company’s ownership may result in a limitation on the amount of net operating loss carryforwards and tax credit carryforwards which may be used in future years.

The Company’s tax provision for the first nine months of fiscal 2017 represented current state margin tax.  For the first nine months of fiscal 2016 the tax provision primarily represents current state margin tax and foreign income tax.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The charge for taxation is based on the results for the year as adjusted for items that are non-assessable or disallowed. The charge is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. Pursuant to Topic 740, “Income Taxes”, the Company will recognize the benefit from a tax position only if it is more likely than not that the position would be sustained upon audit based solely on the technical merits of the tax position. The unrecognized tax benefit at October 28, 2017 was $3.0 million. This amount is directly associated with a prior year tax position related to exiting the Company’s direct business in Europe. The amount of unrecognized tax benefit has been presented as a reduction in the reported amounts of its federal and state net operating loss carryforwards. It is the Company’s policy to record interest and penalties on unrecognized tax benefits as income taxes; however, no penalties or interest have been accrued on this liability because the carryforwards have not yet been utilized.

The Company is subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. The Company has concluded all U.S. federal income tax matters for years through fiscal 2001, with remaining fiscal years subject to income tax examination by federal tax authorities.

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8. Related Parties

Oliver Walsh was elected as a director at the Company’s Annual Meeting of Stockholders on August 3, 2017. On August 17, 2017, Mr. Walsh entered into a temporary consulting agreement with the Company, to serve as the Company’s Interim Chief Marketing Officer through the Fall and Holiday selling seasons, while the Company searches for a new Chief Marketing Officer.  Pursuant to the terms of the temporary consulting agreement, Mr. Walsh is entitled to receive compensation at a rate of $7,000 per week plus reimbursement for all business and travel expenses.  Because of the related party relationship, the temporary consulting agreement was approved by the Company’s Audit Committee.  Through the end of the third quarter of fiscal 2017, Mr. Walsh received total compensation pursuant to the temporary consulting agreement, excluding reimbursement of expenses, of $70,000.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of the United States Private Securities Litigation Reform Act of 1995. In some cases, forward-looking statements can be identified by the use of forward-looking terminology such as “may,” “will,” “estimate,” “intend,” “plan,” “continue,” “believe,” “expect” or “anticipate” or the negatives thereof, variations thereon or similar terminology. The forward-looking statements contained in this Quarterly Report are generally located in the material set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” but may be found in other locations as well, and include statements regarding cash flows, gross profit margins, merchandise margins, marketing costs, selling, general and administrative expenses, store counts, inventory levels, capital expenditures, borrowings, interest costs, sales and earnings expectations for fiscal 2017 and beyond, the expected impact of inventory management improvements on inventory levels and working capital in fiscal 2017, the expected impact of investments in marketing on 2017 sales and longer term impact on customer acquisition and brand awareness, and the anticipated pace and number of store openings and closings in fiscal 2017 and anticipated impact of expanding into Canada or future growth. These forward-looking statements generally relate to plans and objectives for future operations and are based upon management’s reasonable estimates of future results or trends. The forward-looking statements in this Quarterly Report should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements and notes to those statements included elsewhere in this Quarterly Report and our audited consolidated financial statements for the year ended January 28, 2017, included in our Annual Report on Form 10-K for the year ended January 28, 2017, as filed with the Securities and Exchange Commission on March 20, 2017 (our “Fiscal 2016 Annual Report”).

Numerous factors could cause our actual results to differ materially from such forward-looking statements. We encourage readers to refer to the “Risk Factors” section in Part I, Item 1A of our Fiscal 2016 Annual Report, that sets forth certain risks and uncertainties that may have an impact on future results and direction of our Company, including, without limitations, risks relating to the execution of our corporate strategy, and our ability to grow our market share, predict customer tastes and fashion trends, forecast sales growth trends, maintain and build our brand awareness and compete successfully in our market.

All subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the foregoing. These forward-looking statements speak only as of the date of the document in which they are made. We disclaim any obligation or undertaking to provide any updates or revisions to any forward-looking statement to reflect any change in our expectations or any change in events, conditions or circumstances in which the forward-looking statement is based.

BUSINESS SUMMARY

Destination XL Group, Inc., together with our consolidated subsidiaries (the “Company”), is the largest specialty retailer of big & tall men’s apparel with retail and direct operations in the United States, Canada and London, England.  We operate under the trade names of Destination XL^®, DXL^®, DXL Outlets, Casual Male XL^®, Casual Male XL Outlets, Rochester Clothing, ShoesXL^® and LivingXL^®. At October 28, 2017, we operated 211 Destination XL stores, 14 DXL outlet stores, 81 Casual Male XL retail stores, 33 Casual Male XL outlet stores and 5 Rochester Clothing stores. Our e-commerce site, DestinationXL.com, supports our stores, brands and product extensions.  

Unless the context indicates otherwise, all references to “we,” “our,” “us” and “the Company” refer to Destination XL Group, Inc. and our consolidated subsidiaries. We refer to our fiscal years which end on February 3, 2018 and January 28, 2017 as “fiscal 2017” and “fiscal 2016,” respectively. Fiscal 2017 is a 53-week period and fiscal 2016 was a 52-week period.  

SEGMENT REPORTING

We report our operations as one reportable segment, Big & Tall Men’s Apparel.  We consider our retail and direct (e-commerce) businesses, especially in our growing omni-channel environment, to be similar in terms of economic characteristics, production processes and operations, and have, therefore, aggregated them into a single reporting segment.

COMPARABLE SALES

Total comparable sales include our retail stores that have been open for at least 13 months and our direct business.  Stores that have been remodeled or re-located during the period are also included in our determination of comparable sales. Stores that have been expanded by more than 25% are considered non-comparable for the first 13 months.  If a store becomes a clearance center, it is also removed from the calculation of comparable sales.  The method of calculating comparable sales varies across the retail industry and, as a result, our calculation of comparable sales is not necessarily comparable to similarly titled measures reported by other retailers.  

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As we disclosed at the end of fiscal 2016, with over 200 DXL stores open, we have transitioned to one comparable sales figure for the Company which includes stores and our e-commerce business.  We no longer provide comparable store sales on a discrete basis for our DXL format stores.     

In addition, our customer’s shopping experience continues to evolve across multiple channels and we are continually changing to meet his needs.  As part of our omni-channel initiatives, the majority of our retail stores have the capability of fulfilling online orders if merchandise is not available in the warehouse.  As a result, we continue to see more transactions that begin online but are ultimately completed at the store level.  Similarly, if a customer visits a store and the item is out of stock, the associate can order the item through our website.  A customer also has the ability to order online and pick-up in store.  Because this omni-channel approach to retailing is changing the boundaries of where a sale originates and where a sale is ultimately settled, we do not report comparable sales separately for our retail and e-commerce businesses.  However, as we invest in building our e-commerce platform, bringing a heightened digital focus to our Company, additional disclosure on our e-commerce growth as it relates to our current initiatives is important.  Beginning in the second quarter of fiscal 2017, we define store sales as sales that originate and are fulfilled directly at the store level.  E-commerce sales are defined as sales that originate online, including those initiated online at the store level.  This reclassification on how we define a store sale from an e-commerce sale had no effect on our previous disclosure or how we report total Company comparable sales.

RESULTS OF OPERATIONS

The following is a summary of results for the third quarter and first nine months of fiscal 2017 as compared to the prior year’s third quarter and first nine months, including EBITDA, which is a non-GAAP measure. Please see “Non-GAAP Financial Measures” below for a reconciliation of Net Loss to EBITDA.

Executive Summary

Our sales for the third quarter were below expectations and were negatively impacted by the delayed arrival of cold weather in the Northeast and Hurricanes Irma and Harvey.  We believe that our customer is a need-based shopper and the onset of cold weather is typically when he comes to shop.  Comparable sales for our DXL stores in the Northeast region trailed our stores in the rest of the country by approximately 400 basis points.  We estimate that the negative impact of the comp sales of our Northeast stores on our total comparable sales of (0.1%) for the third quarter was approximately 90 basis points.  Additionally, from a merchandising category perspective, our cold weather categories trended behind the remainder of our merchandise assortment by over 10% for the third quarter and over 20% for the month of October. With the cold weather arriving in the first few weeks of the fourth quarter, we are beginning to see an improvement in comparable sales performance.  In addition to the unseasonably warm weather during the quarter, we also had 34 stores that were closed for at least one day, with the majority closed three to four days, as a result of Hurricanes Irma and Harvey. We estimate that the combined impact from both storms on our comparable sales for the third quarter was approximately 50 basis points.  

Despite, the warm weather and hurricanes, which contributed to a decrease in store traffic, we are pleased with our sales productivity in our stores, with average dollars per transactions, units per transaction and conversion all increasing over the prior year.  We remain committed to driving traffic to our stores and website and building brand awareness as we head into the fourth quarter of fiscal 2017.  We are pleased to have launched our new Holiday advertising campaign and believe our integrated social, digital and media marketing plan, which we discuss below, will drive traffic to our stores and website.

During the third quarter of fiscal 2017, as part of our ongoing inventory initiatives, we took an aggressive approach to moving some of our traditional slower-moving categories, which resulted in increased markdowns for the quarter and decreased merchandise margins from a year ago of approximately 120 basis points.  On a comparative basis with the end of the third quarter of the prior year, we have reduced inventories by approximately $8.3 million, or 6.5% at October 28, 2017, with minimal impact to our merchandise margin which, on a year-to-date basis, has decreased by only 40 basis points compared to the prior year. We expect our merchandise margins to return to a more normalized level in the fourth quarter due to fewer merchandise markdowns.  This initiative has enabled us to reduce our inventory thereby improving our working capital and free cash flow.

Our net loss for the third quarter of fiscal 2017 was $(5.7) million, or $(0.12) per diluted share, as compared to a net loss of $(4.5) million, or $(0.09) per diluted share, for the third quarter of fiscal 2016.  For the first nine months of fiscal 2017, the net loss was $(15.5) million, or $(0.32) per diluted share, as compared to a net loss of $(4.0) million, or $(0.08) per diluted share for the prior year

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period.  Included in net loss for the first nine months of fiscal 2017 was an impairment charge of approximately $1.7 million, or $0.03 per diluted share, for the write-down of certain store assets and an increase of approximately $4.2 million, or $0.09 per diluted share, in advertising costs.  

In the first nine months of fiscal 2017, we opened a total of 20 stores, which includes two DXL retail stores in Ontario, Canada.  These two stores mark our first Company-operated DXL stores located outside of the United States.  We believe that Canada provides a strategic growth opportunity for our DXL brand.  In addition, for fiscal 2017 we expect to close approximately 19 Casual Male XL stores and 3 Casual Male XL outlet stores, the majority of which are in connection with the opening of the DXL retail and outlet stores in the same geographic market.  Of the 114 Casual Male XL stores in operation, 112 are generating positive free cash flow.

Marketing Campaign ~ Holiday 2017

As we discussed last quarter, we are committed to improving brand awareness, driving traffic to our stores and growing our e-commerce business through a robust investment in both our traditional and digital marketing programs. Our new marketing campaign, “Time to XL,” launched on social media and on our website on November 7, 2017. Our new creative ad will begin to air on television starting November 25, 2017 and will run through the Christmas holiday.  In addition to our digital and media advertising, we will also be sponsoring the Frisco Bowl college football game on December 20, 2017.  Our new campaign is centered on changing the conversation around Men’s XL apparel and celebrating the style of our customer base.  The campaign features prominent brand ambassadors, including 10-time MLB All-Star David Ortiz, producer and artist DJ Khaled, singer and songwriter Sundance, NHL Stanley Cup winner Hal Gill and fashion blogger Kelvin Davis; five celebrities with larger-than-life personalities, each with his own sense of #XLstyle.  We want the XL community to know who we are and that we “XL” at service, selection, comfort and fit. We are confident that this campaign will signal a new chapter in the DXL store and we are hopeful that the campaign will drive brand awareness and new customers to our DXL brand.  

Stock Repurchase Program

As discussed more fully below under “Liquidity and Capital Resources,” in March 2017 our Board of Directors approved a stock repurchase plan, pursuant to which we may purchase up to $12.0 million of our outstanding common stock during fiscal 2017.  During the first nine months of fiscal 2017, we repurchased approximately 1.9 million shares at a total cost of approximately $4.7 million.  There were no stock repurchases during the third quarter of fiscal 2017.

Inventory Management Review

In fiscal 2016, we began our inventory optimization project in an effort to improve inventory receipt flow and procurement, tightening controls over the number of weeks of supply and refining our in-stock positions by sku level.  We expect these changes to result in a more optimized inventory structure and expect our inventory at the end of fiscal 2017 to be $12.0 to $15.0 million less than fiscal 2016.  This reduction in inventory is expected to improve our working capital position and partially reduce our debt in fiscal 2017. At the end of the third quarter of fiscal 2017, we were ahead of plan having reduced inventory levels by $8.3 million, or a decrease of 6.5%, as compared to the end of the third quarter last year.  We do not believe these changes have jeopardized sales from out-of-stock positions in either our retail stores or in our direct business.  

Fiscal 2017 Outlook

As a result of our sales falling below expectations due in part to the delay of cold weather, we are revising our guidance.  In the second quarter of fiscal 2017, we increased our marketing expense for fiscal 2017 to $29.0 million to help drive brand awareness, store traffic and our digital presence.  This is an increase of approximately $10.8 million from fiscal 2016. While we expect this will benefit sales in the fourth quarter of fiscal 2017, we strongly believe that this investment in marketing and customer acquisition was important for our long-term growth.  We currently expect to open 20 DXL retail stores and 1 DXL outlet store in fiscal 2017, while closing 19 Casual Male XL retail stores and 3 Casual Male XL outlet stores, the majority of which are in connection with the opening of the DXL retail and outlet stores in the same geographic markets. All DXL store growth for the year will be funded by cash from operations.  

For fiscal 2017, our revised outlook, based on a 53-week year, is as follows:

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Financial Summary

Sales

Total sales for the third quarter of fiscal 2017 increased 1.8% to $103.7 million from $101.9 million from the third quarter of fiscal 2016.  The increase of $1.8 million in total sales was due to non-comparable sales of $6.4 million and other revenue of $0.4 million, partially offset by a decrease in sales from closed stores of $4.9 million and a comparable sales decrease of $0.1 million, or (0.1)%.   As discussed above, sales for the third quarter were impacted by the unseasonably warm weather and the hurricanes which impacted our Florida and Texas stores.  While store traffic was down 5% for the third quarter, we did see increases in sales productivity with increases in average dollars per transactions, units per transaction and conversion.  

For the first nine months of fiscal 2017, sales increased $4.8 million, or 1.5%, as compared to the first nine months of fiscal 2016.  The increase in sales was primarily due to non-comparable sales of $23.0 million, partially offset by sales from closed stores of $17.5 million and a decrease of 0.5%, or $1.6 million, in comparable sales.  

With our transformation of our store base complete, we are focused on growing our e-commerce business and improving store productivity through an integrated strategy. We are implementing several initiatives to enhance our digital presence and provide our customers with improved functionality and increased touchpoints across all of our e-commerce platforms with the objective of growing and retaining our customer base.  On a trailing twelve-month basis, e-commerce sales as a percentage of net sales were 20.8% at the end of the third quarter of fiscal 2017 as compared to 19.5% at the end of the third quarter of the prior year.

Our end-of-rack customer grew to 45.3% of our bottoms business from 44.8% in the third quarter of fiscal 2016.  Our end-of-rack customer, with a waist size of 46 inches or less, shops 52% more often than our customer with a waist size of 48 inches or more and, on an annual basis, spends twice as much.  

Gross Profit Margin

For the third quarter of fiscal 2017, our gross margin rate, inclusive of occupancy costs, was 43.2% as compared to a gross margin rate of 44.4% for the third quarter of fiscal 2016. The decrease of 120 basis points was due to a decrease in merchandise margins of 120 basis points.  The decrease in merchandise margin was related to an increase in promotional markdowns related to our inventory productivity initiatives as compared to the prior year’s third quarter. In addition, during the third quarter we took an aggressive approach to move slow-moving and clearance inventory, which also contributed to an increase in markdowns.  As a result, our

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clearance inventory at October 28, 2017 was 7%, a decrease from 9% at October 29, 2016.  Occupancy costs, as a percentage of sales, remained flat.

For the first nine months of fiscal 2017, our gross margin rate, inclusive of occupancy costs, was 44.9% as compared to a gross margin rate of 45.7% for the first nine months of fiscal 2016.  The decrease of 80 basis points was due to a 40 basis point decrease in merchandise margins and a 40 basis point increase in occupancy costs.  The increase in occupancy costs was primarily due to an increase in DXL total square footage and the comparable sales decline.  On a dollar basis, occupancy costs for the first nine months of fiscal 2017 increased approximately 4.2% over the prior year’s first nine months, primarily as a result of an increase of 1.5% in total square footage and the increased percentage of DXL stores.

The decrease of 40 basis points in merchandise margins for the first nine months of fiscal 2017 as compared to the prior year was due primarily to our inventory initiatives and increased efforts to reduce slow-moving merchandise categories which resulted in higher promotional markdowns than the prior year.  Our inventory initiatives have resulted in a 6.5% decrease in inventory levels from a year ago, improved inventory turn and days on hand, while at the same time managing a strong merchandise margin.  

Selling, General and Administrative Expenses

As a percentage of sales, SG&A expenses for the third quarter of fiscal 2017 were 40.5% as compared to 40.6% for the third quarter of fiscal 2016. For the first nine months of fiscal 2017 SG&A expenses as a percentage of sales were 41.3% as compared to 39.4% for the first nine months of fiscal 2016.  On a dollar basis, SG&A increased by $0.6 million and $8.2 million for the third quarter and first nine months of fiscal 2017, respectively.  The increase in the third quarter of fiscal 2017 was primarily due to increases in store payroll and other supporting costs associated with our DXL store base and e-commerce initiatives.  

For the first nine months of fiscal 2017, the increase was principally due to an increase of $4.2 million in advertising expense. As discussed above, we are increasing our investment in our marketing initiatives to help drive brand awareness, store traffic and our digital presence. The remainder of the increase was due to increases in store payroll and other supporting costs associated with a greater DXL store base and e-commerce initiatives.    

Depreciation and Amortization

Depreciation and amortization for the third quarter of fiscal 2017 increased $0.2 million to $7.7 million as compared to $7.5 million for the third quarter of fiscal 2016.  

For the first nine months of fiscal 2017, depreciation and amortization was $25.1 million as compared to $22.4 million for the first nine months of fiscal 2016.  The increase of $2.7 million includes a $1.7 million impairment charge taken in the second quarter of fiscal 2017 to write-down certain store assets. The remainder of the increase was due to the continued store growth associated with our DXL retail and outlet stores.

Interest Expense, Net

Net interest expense for the third quarter and first nine months of fiscal 2017 of $0.9 million and $2.5 million, respectively, increased slightly from $0.8 million and $2.3 million, respectively, for the third quarter and first nine months of fiscal 2016.  As a result of our inventory initiatives undertaken to improve liquidity, we expect interest costs for fiscal 2017 will be similar to fiscal 2016 levels.  

Income Taxes

At October 28, 2017, we had total deferred tax assets of $84.4 million, total deferred tax liabilities of $12.6 million and a corresponding valuation allowance of $72.0 million. The deferred tax assets included approximately $59.4 million of net operating loss carryforwards and approximately $4.7 million of deferred gain on our sale-leaseback and, to a lesser extent, other book/tax timing differences.

At the end of fiscal 2013, we established a full valuation allowance against our deferred tax assets.  Based on our earnings guidance for fiscal 2017, we believe that a full valuation allowance continues to remain appropriate at this time.

Our tax provision for the third quarter and first nine months of fiscal 2017 represented current state margin tax. For the third quarter and first nine months of fiscal 2016, the tax provision represented current state margin tax and foreign income tax.

Net Loss

For the third quarter of fiscal 2017, we had a net loss of $(5.7) million, or $(0.12) per diluted share, compared with a net loss of $(4.5) million, or $(0.09) per diluted share, for the third quarter of fiscal 2016.

For the first nine months of fiscal 2017, we had a net loss of $(15.5) million, or $(0.32) per diluted share, compared with a net loss of $(4.0) million, or $(0.08) per diluted share.  Results for the first nine months of fiscal 2017 included an impairment charge of $1.7 million, or $0.03 per diluted share, associated with write-down of store assets, and increased advertising costs of $4.2 million, or $0.09 per diluted share.

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On a non-GAAP basis, assuming a normalized tax rate for both periods, adjusted net loss per share for the third quarter and first nine months of fiscal 2017 was $(0.07) per diluted share and $(0.19) per diluted share, respectively, as compared to adjusted net loss of $(0.05) per diluted share and $(0.05) per diluted share, respectively, for the third quarter and first nine months of fiscal 2016.  

Inventory

At October 28, 2017, total inventory was $119.9 million compared to $117.4 million at January 28, 2017 and $128.2 million at October 29, 2016. The 6.5% decrease of $8.3 million from October 29, 2016 was due to inventory initiatives that began in fiscal 2016 to improve timing of receipts and reduce weeks of supply on hand. At October 28, 2017, our clearance inventory represented 7.0% of our total inventory, as compared to 9.0% at October 29, 2016.  

SEASONALITY

Historically, and consistent with the retail industry, we have experienced seasonal fluctuations as it relates to our operating income and net income. Traditionally, a significant portion of our operating income and net income is generated in the fourth quarter, as a result of the “Holiday” season.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity are cash generated from operations and availability under our credit facility with Bank of America, N.A., which was most recently amended in October 2014 (“Credit Facility”). Our current cash needs are primarily for working capital (essentially inventory requirements), capital expenditures, growth initiatives, and, as discussed further below, our stock repurchase program, which was announced in March 2017.

As discussed below, our capital expenditures for fiscal 2017 are expected to be approximately $22.0 million, primarily related to the planned opening of approximately 20 new DXL retail and 1 outlet stores and information technology projects. However, we expect to receive approximately $5.0 million in tenant allowances to offset these capital expenditures. We expect to fund this store growth and stock repurchase program in fiscal 2017 primarily through cash flow from operations, with periodic borrowings from our Credit Facility. We currently believe that our existing cash generated by operations together with our Credit Facility will be sufficient within current forecasts for us to meet our foreseeable liquidity requirements.

For fiscal 2017, we expect cash flow from operating activities of $31.0 million to $35.0 million (including tenant allowances), and positive free cash flow of $9.0 to $13.0 million that will be used to reduce outstanding debt and purchase shares of the Company’s common stock as part of its stock repurchase program.  

For the first nine months of fiscal 2017, free cash flow improved by $0.5 million to $(13.2) million from $(13.7) million for the first nine months of fiscal 2016. The improvement in free cash flow was primarily due to the lower capital expenditures and positive working capital changes, partially offset by reduced earnings.

The following is a summary of our total debt outstanding at October 28, 2017 with the associated unamortized debt issuance costs:  

Credit Facility

Our credit facility with Bank of America, N.A., effective October 29, 2014 (our “Credit Facility”) provides for a maximum committed borrowing of $125.0 million, which, pursuant to an accordion feature, may be increased to $175.0 million upon our request and the agreement of the lender(s) participating in the increase. The Credit Facility includes a sublimit of $20.0 million for commercial and standby letters of credit and a sublimit of up to $15.0 million for swingline loans. The maturity date of the Credit Facility is October 29, 2019. Our Credit Facility is described in more detail in Note 2 of the Notes to the Consolidated Financial Statements included in this Quarterly Report.

Borrowings made pursuant to the Credit Facility bear interest at a rate equal to the base rate (determined as the highest of (a) Bank of America N.A.’s prime rate, (b) the Federal Funds rate plus 0.50% and (c) the annual ICE-LIBOR (“LIBOR”) rate for the respective interest period) plus a varying percentage, based on our borrowing base, of 0.50%-0.75% for prime-based borrowings and 1.50%-1.75% for LIBOR-based borrowings.

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We had outstanding borrowings of $68.4 million under the Credit Facility at October 28, 2017. At October 28, 2017, outstanding standby letters of credit were $3.3 million and outstanding documentary letters of credit were $0.1 million.  The average monthly borrowing outstanding under the Credit Facility during the first nine months ended October 28, 2017 was approximately $60.4 million, resulting in an average unused excess availability of approximately $43.3 million. Unused excess availability at October 28, 2017 was $38.2 million. Our obligations under the Credit Facility are secured by a lien on substantially all of our assets, excluding (i) a first priority lien held by the lenders of the Term Loan Facility on certain of our equipment described below and (ii) intellectual property.  

Equipment Financing Loans

We have entered into twelve Equipment Security Notes (the “Notes”), whereby we borrowed an aggregate of $26.4 million. The Notes, which were issued between September 2013 and June 2014, were issued pursuant to a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC, dated July 20, 2007 and most recently amended on September 30, 2013. The Notes are secured by a security interest in all of our rights, title and interest in and to certain equipment. The Notes are for 48 months and accrue interest at fixed rates ranging from 3.07% to 3.50%. Principal and interest, are payable monthly, in arrears. The Company was subject to prepayment penalties through the second anniversary of each note.  The Company is no longer subject to any prepayment penalties.

Term Loan, Due 2019

We have a $15.0 million senior secured term loan facility with Wells Fargo Bank, National Association as administrative and collateral agent (the “Term Loan Facility”). The Term Loan Facility bears interest at a rate per annum equal to the greater of (a) 1.00% and (b) the one month LIBOR rate, plus 6.50%.  Interest payments are payable on the first business day of each calendar month, and increase by 2% following the occurrence and during the continuance of an “event of default,” as defined in the Term Loan Facility. The Term Loan Facility, which matures on October 29, 2019, provides for quarterly principal payments on the first business day of each calendar quarter, which commenced the first business day of January 2015, in an aggregate principal amount equal to $250,000, subject to adjustment, with the balance payable on the termination date.

The Term Loan Facility includes usual and customary mandatory prepayment provisions for transactions of this type that are triggered by the occurrence of certain events.  In addition, the amounts advanced under the Term Loan Facility can be optionally prepaid in whole or part without penalty.  

The Term Loan Facility is secured by a first priority lien on certain of our equipment, and a second priority lien on substantially all of our remaining assets, excluding intellectual property.

Capital Expenditures

The following table sets forth the open stores and related square footage at October 28, 2017 and October 29, 2016, respectively:

Below is a summary of store openings and closings from January 28, 2017 to October 28, 2017: