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Q3 2023 Designer Brands Inc Earnings Call

Participants

Ashley Firlan; IR; Edelman Smithfield

Douglas Howe; CEO; Designer Brands Inc.

Laura Denk; EVP; Designer Brands Inc.

Jared Poff; EVP, CFO, Chief Administrative Officer; Designer Brands Inc.

Gabby Carbone; Analyst; Deutsche Bank AG

Jay Sole; Analyst; UBS Group AG

Presentation

Operator

Welcome to the Designer Brands Third Quarter 2023 earnings conference call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions please note, this event is being recorded.
I'd now like to turn the conference over to Ashley for Olin with Ellman Smithfield. Please go ahead.

Ashley Firlan

Good morning. Earlier today, the company issued a press release comparing results of operations for the 13-week period ending October 28, 2023 for the 13-week period ended October 29, 2022. Please note that the financial results that we will reference during the remainder of today's call exclude certain adjustments recorded under GAAP, unless specified otherwise for a complete reconciliation of GAAP to adjusted earnings, please reference our press release. Additionally, please note that remarks made about the future expectations, plans and prospects of the Company constitute forward-looking statements. Results may differ materially due to various factors listed in today's press release and the Company's public filings with the SEC. The Company assumes no obligation to update any forward-looking statements.
Joining us today are Doug Hao, Chief Executive Officer, Jerry Pellizzon, Chief Financial Officer, and Laura de (unk), President of DSW. I'll now turn the call over to Doug.

Douglas Howe

Good morning, everyone.
Thank you for joining us today. the third quarter was difficult for our business. Macro headwinds continue to impact us most acutely within our retail segment traffic as consumers remain under pressure and the overall footwear market contracted for the first time since the pandemic because our business is heavily weighted towards dress and seasonal, unseasonably warm weather also had an outsized impact on our top line. We also faced headwinds that we believe demonstrate our need to operate with even greater speed while increasing the level of innovation, newness and fashion in our assortments. To this end, we have made several strategic decisions regarding leadership across our organization, and we will be diligent as we embark on the journey of backfilling these roles in order to best position our business for the future.
During our second quarter earnings call, we communicated that our full year guidance assumed we set at a key inflection point and a retail comp performance would need to meaningfully improve, supported by a strong September throughout the balance of the year. In order to meet our expectations, we also noted the possibility for headwinds to worsen further something that could hamper the sequential improvement we require during the third quarter, we experienced a sales shortfall within the fall season, specifically September, particularly related to broad-based weakness in seasonal and dress. Conversely, the casual portion of our retail business continued to perform well, delivering comp sales growth in the mid-single digits. We also see the retail customer continuing to lean into value and the intentional rebuild of our clearance business within our US retail segment helped to slightly offset broader declines. Clearance sales were down only 3%, significantly better than our total sales, which were down 9%. However, none of these were significant enough to offset the precipitous decreases we experienced in dress and more notably in boots within our retail segment, which includes DSW stores, Shoe Company and their related e-commerce site. Our top line fell short of our expectations, driven by seasonal product demand. Specifically boot demand falling meaningfully year over year. This was a dynamic felt industry-wide. We have long been a market leader in seasonal footwear, which is boots and sandals, and this continued to represent a material portion of our sales in Q3. According to circ on a third quarter, seasonal footwear was down 16% based on dollar sales over the last year in the total market, which was in line with our performance at DSW. However, while seasonal footwear represents about 20% of the total market in the third quarter, it represented nearly 40% of DSW's business, resulting in disproportionate pressure on our performance as we look across our entire assortment and continue to learn more about evolving consumer preferences in both category mix and shopping channels. We are adapting our own strategic approach. We know we can perform better across all categories, including nonseasonal and get back to our roots of being a product lead, data-driven merchant organization, quick to supply a product that meets the trends the customer is leaning into to that end. I am excited by the skilled and experienced merchant leadership we have brought to the business and Laura Danek, our newest President of DSW, will speak to strategic initiatives. Her team is pursuing shortly, we met our expectations in our Brand Portfolio segment with overall sales down 12.5%, in line with our expectations. Declines in our legacy brands. Wholesale business were offset by the additions of Keds, towboat and Hush Puppies as well as strong performance at ABC.com. We are building momentum and gaining traction across our brand portfolio as we continue to prioritize long-term sustainable growth within this segment.
At the beginning of our brand-building journey, the portfolio we controlled was highly focused on dress and seasonal with significant whitespace opportunities in the casual and athleisure space, which drove us to make key acquisitions. Since that time, we have made notable progress, growing our portfolio and doubling the sales of our own brands across DBI.'s business continues to be central to our growth story moving forward. At telco specifically, we saw a sequential increase in the quarter and a significant improvement in our DTC. site throughput. In October, we launched three new shoes, including a new waterproof trail runner and new low top hiker. We also refreshed the ST. five, which pairs a minimally Christian zero drop platform with topo signature fit for a natural comfortable run experience and or workout session at the gym.
I want to take a moment to thank our partners at REI., a key retail partner for us as we continue to expand our partnership and increase brand awareness for Turbo. Vince Camuto, the brand posted its highest demand day of 2023 in the quarter, as well as the largest full-price non-promotional day in DC.com history, spurred by the incredibly successful first-ever influencer collaboration with Dress Up butter cup a lifestyle brand by DD. red, who has over $1 million followers on Instagram to celebrate the launch influencers attended a branch in Nashville, Tennessee, helping to drive significant publicity as we look to expand our specialty size business, which Laura will speak to in a moment. This recent launch has given us yet another proof point that Wildcat boots are in high demand and given the limited options available that address this market, we will continue to provide new offerings to capture share another way we are strategically evolving our assortment and listening to our customers year over year VC. dot com comp sales were up 7% for the quarter. Importantly, Vince Camuto remains in an excellent position to expand the total addressable market for our own brands with significant opportunity in both men's and women's wide with shoes.
Before I hand it over to Laura, I want to thank our team for their dedicated execution in this very challenging environment we are digging in, we will adapt, and I'm confident in our ability to navigate this backdrop and make progress on our long-term vision. Designer Brands is unlike any other company in the footwear industry. And I believe this unique model will allow us to grow our competitive edge as we aim to ride our business for the future.
We continue to prioritize building out our leadership team with the right skill set to ensure our product focus aligns within our customers' preferences. As a first step, Laura has hit the ground running and has begun laying the groundwork for key strategic updates. To elaborate on some of these priorities for DSW, please join me in welcoming DSW's President, Laura Danek, Laura, thank you, Doug, and hello, everyone.

Laura Denk

It's an honor to speak with you all today. And my first 100 days, my priority has been to work closely with the management team and great associates at DBI. to learn ins and outs of the business. I've also talked of customers and national brand partners and visited many stores throughout the country. There is a universal passion for DSW, and it's been exciting to witness. The power of our brand has also been important to me to hear firsthand where the biggest issues and therefore, areas of opportunity are as I boil this down. I believe that while DSW is certainly feeling the brunt of a very pressured industry, there are elements of our business where we can employ more focus and discipline. According to STAR Kona, the total footwear market was down in the third quarter year over year. The first quarter has seen a decline since Q4 of 2020, but DSW's performance also lagged the overall market as they work to unpack why and what we need to prioritize. I'm intently focused on three key areas in the near term to drive improvement, one, reinvigorating our assortment to optimizing our market investments and three, enhancing our in-store and digital shopping experiences. First, our assortment at DSW and across all of designer brands. It starts and ends with product. We can't lose sight of how important an optimal and differentiated assortment is our assortment. The size of which was historically unparalleled is what made DSW, the dominant retailer it is today and maintaining an energizing and trend-right assortment is even more critical today. And the customer has substantially more options from brands that are moving more quickly than ever over the last few years, designer brands has contended with a number of unforeseen events, not the least of which included the COVID pandemic and subsequent recovery demand further complicated by global supply chain issues amidst these external challenges, we've also been focused on driving vertical integration internally with a number of these challenges now behind us and an evolved business model, I believe we can turn more of our focus to accelerating the alignment of our overall assortment more closely to what customers are demanding as it stands currently, we can do more to bring the hottest brand and the excitement that comes with them to DSW's assortments to reinforce a differentiated and relevant offerings.
My vision for DSW's assortment is trend-right shoes that align with consumer demand, we need to get back to our heritage with a relentless flow of newness, key designer fines and creating SoMo in order to ensure we can maintain our position as a fashion footwear retailer. I have given our buyers a direction to maintain greater liquidity, listen to our consumers and seize opportunistic buys more tactically, I plan to leverage DSW's unique data and insights from our database of nearly 30 million loyalty members to identify trends and dynamically adjust our offerings and our marketing to provide a selection that resonates with evolving consumer preferences. This product-led data-driven assortment strategy brings back the passion and creativity that good merchants thrive on, including building strong and growing relationships with our national brand partners. We remain a sought-after partner for top national brands. Given our highly attractive customer base with our unparalleled access to the female athlete and the growing demand for athletic and athleisure product, these brands continue to prioritize placement in our channels. For example, Nike product began coming back online in September and as of early November is fully rolled out in all DBI. channels. Nike has instantly become one of our top national brands, both in stores and through our e-commerce site, and we couldn't be happier with this relationship. We are also pleased to see other national brands returning to DSW. And this spring, we plan to bring Under Armour back into our collection of high quality offerings. We're also excited for our dominant and growing relationships with Birkin stock and Skechers. And while the assortment must be relevant, we need to remind the consumer why DSW should be their preferred footwear retailer because we remain a leader in the industry, but in recent years has started to see DSW brand awareness at Road. We are still leading the footwear industry with our award winning VIP. program, which boasts nearly 30 million members. We have not been as diligent about one driving awareness among potential new customers and to communicate our continuously refreshed and renewed assortment and convenient shopping experience to our existing loyalty members. As such, I gain conviction that we must start investing again in top of funnel marketing and broad communications to grow the awareness that we are the best in shoes. As a first step in October, we significantly increased investment and top of funnel marketing, inclusive of an inspiring video campaign to reach over 75% of DSW's female target audience. While top-of-funnel marketing takes time to translate into tangible transactions today, early reads are encouraging that more simply having the right assortment is only half the battle DSW needs to continue to more loudly, articulate the variety and quality of our assortment to emphasize our unique position of footwear and remind the customer why they should choose DSW for all of their footwear needs.
Finally, I also feel strongly that we must always be invest in our customer experience, including our store fleet. The customer has more choices than ever as to where and how to shop for footwear, and we must provide an experience as frictionless and easy to navigate. In addition to constantly evolving our digital and omni capabilities to improve conversion and engagement. We are looking across our store footprint and evaluating opportunities to selectively invest in refreshing this experience to stay modern, relevant and provide an experience that Internet pure plays cannot. We've taken a thoughtful customer first approach asking what is important to them and subsequently testing new approaches to certain aspects of the shopping experience. We are analyzing feedback from test stores in Houston, Columbus and Oregon and prioritizing those aspects, which will have the biggest impact. We are in the early stages on this, but the customer reaction has been encouraging, and we are excited to continue testing and learning. As we move forward. Our teams will continue to develop a holistic strategy that we'll lean into a fresh, exciting assortment, new marketing initiatives and refreshed in-store and digital experiences.
Thank you again, Doug, for having me join the conversation today. And with this, I will turn the call over to Jared for an overview of our financial results.

Jared Poff

Jared Thank you, Laura, and good morning, everyone. I want to reiterate Doug's comments as this is a difficult time for our business and the broader footwear industry. As he mentioned, the improvements that we were anticipating on both top and bottom line did not materialize. And the net risk position that I had called out on our last earnings call came to fruition. This quarter. The top line weakness ultimately flowed through leading to operating deleverage against a largely fixed expense base and resulted in an adjusted EPS of $0.24. Our team is aware of the factors that led to this situation and is making progress on sustainable improvements across all elements of the business based on what we have seen through the fourth quarter to date. We do not expect these sales pressures to alleviate as we wrap up this year, especially given the ongoing uncertainty in the macro environment.
Let me provide a bit more detail on our Q3 financial results for the third quarter, sales decreased 9.1% from last year to $786.3 million. From a wholesale perspective, sales were down roughly 22.7% in line with expectations as we lapped strong wholesale sales unlocked by pent-up demand in that channel last year following supply chain disruptions, US retail comps specifically were down 9.8% in the quarter, while Canada posted comps down 7.7% in the quarter. One bright spot was our Vince Camuto.com business, one of our premier DTC channels with comps up 7% in the quarter on top of a 27% comp last year and up 26.3% for the month of October. This quarter's success was largely driven by the brand's decision to lean into strong consumer demand for wide and Extra Wide shafted boots. Consolidated gross margin was 32.6% in the third quarter compared to 33% last year, a decrease of 40 basis points, driven primarily by an increase in promotional pricing and the deleverage of our fixed store occupancy costs offset by lower freight and shipping costs. That being said, our gross margin continues to be fundamentally stronger than pre-pandemic with consolidated gross margin up 330 basis points compared to the third quarter of 2019. And we will continue to look for ways to bring further efficiencies to our operating model. Our adjusted SG&A ratio for the third quarter was 28.9% of sales compared to 25.5% in the third quarter of 2022, driven primarily by deleverage from the top line pressures against an increasingly fixed expense base, along with an increase in marketing expense.
As Laura mentioned, for the third quarter, adjusted operating profit was 4% of sales compared to 7.8% for the prior prior year quarter. In the third quarter, we had $8.8 million of net interest expense and our effective tax rate on our adjusted results was 34.6% compared to 25.9% last year. Finally, our third quarter adjusted net income was $14.8 million or $0.24 diluted EPS versus $46.1 million or $0.67 last year. We ended the third quarter with inventories of $601.5 million, down roughly 12% compared to $681.8 million last year and down sequentially from $606.8 million in the second quarter. On a retail inventory per square footage basis, we ended down 11.5% versus the third quarter of 2022. Wholesale inventory ended the third quarter, up 2% and adjusted for the acquisition of Turbo and kids, inventory would have been down roughly 20% when compared to last year. Headed into the fall, we were acutely aware of the net risk position we were facing. And as such, we were very strategic with our inventory investments. We continue to remain nimble in our approach to our assortment as we prioritize maintaining a healthy inventory position, we strategically deployed promotions for Black Friday and Cyber Monday, which helped to drive traffic in stores and online. While the current environment is operationally challenging. Our strong and steady cash flow generation and liquidity remain a bright spot. Year to date through Q3, we have generated approximately $203 million of net cash provided by operating activities compared to $38 million during the same period last year and the third quarter of fiscal 2023. We also returned $82.5 million to shareholders through dividends and share repurchases year to date, that is a total of $111.5 million. In addition to generating meaningful cash flow from operating activities we further bolstered our liquidity position by arranging for a term loan in the second quarter. This action has given us ample liquidity to manage through turbulent times like this, while also allowing us to return cash to shareholders in the form of dividends and opportunistic share repurchases, something that we believe showcases our conviction and DBI.'s long-term strategy. We ended the quarter in a solid liquidity position with $54.6 million of cash and our total liquidity, which includes cash and availability under our revolver of $267.9 million. As of the end of the quarter, we had $213.3 million available to draw on our revolving credit facility on October 31, 2023, we borrowed $25 million of the $85 million available under our new term loan with any remaining delayed draw loans to be taken by January 31 of 2024. We remain well inside of all covenants and have strong relationships with all of our credit providers. Total debt outstanding was $375.5 million as of the end of the quarter. We continue to await the receipt of our remaining 40 million of our CARES Act tax refund due to us from the IRS. As a reminder, the IRS has formally closed our standard audit for which this refund applies with no adjustments. And as such, we are now simply waiting on the refund request to work its way through the approved appropriate approval channels at the IRS and TREASURY DEPARTMENT for ultimate funding. Given the quarter's results, we are addressing our full year outlook. We are now planning for DBI. net sales to be down high single digits, with retail comps also down high single digits for the year, implying DBI. net sales to be flat to down low single digits for the fourth quarter when taking into account the 53rd week. While we don't anticipate, we will see the demand that we lost in September boot sales materialize in the fourth quarter, we will remain in a competitive posture to keep our inventory at an appropriate level in order to do so. Higher promotions will continue to be necessary. This all results in expected adjusted EPS for the full year in the range of $0.4 to $0.7. The change in this revised adjusted EPS expectation is a substantially larger percentage change than the change in top line expectations as a result of a highly fixed expense base, which is anticipated to come in as originally communicated, our weighted average diluted shares outstanding are anticipated to be approximately $57 million for the fourth quarter and approximately $64 million for the fiscal year. Given the share repurchase activity that has occurred thus far throughout the year. With this, we are immediately taking actions dog and Laura mentioned to address the top line issues that are unique to us and believe we have identified areas that will yield meaningful results in the future for DSW. We have also discussed these the changes we are making in our Brand Portfolio segment, including finding an experienced and seasoned leader to run this business and anticipate outsized growth from this part of our business as we look across our longer-term horizon. And as always, we will be looking for ways to bring further efficiencies to our operating model moving forward, including efficiencies in operating expenses and interest expense. This will take time and we anticipate that our current fixed expense structure will continue to result in operating deleverage in Q4. As Doug noted, we are laser focused on accelerating our ongoing strategies that are working and tactically addressing areas of the business that are not performing as desired. While our results were disappointing, our team is more energized than ever to build solutions towards a more resilient and dynamic enterprise model.
With that, I would like to turn to the operator for Q&A.

Question and Answer Session

Operator

Operator, we will now begin the question and answer session. To ask a question. You may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then two. First question is from Gabby Carbone of Deutsche Bank. Please go ahead.

Gabby Carbone

I think so much for taking my question. So I just wanted to dig in on your brand awareness comments. You mentioned that's eroded a bit. Maybe if you dig a little further into the investments you're making to bring the customer back to the store, do you think your target customer has changed at all? And then maybe how should we be thinking about the impact from that top of funnel marketing you mentioned on kind of SG&A moving ahead?

Douglas Howe

Thank you.
Good morning, Gary, this is Doug.
Thanks for your question?
Yes.
As we talked about, we invested in top-of-funnel marketing, which was episodic video in the quarter. As you know, those take time to be able to measure the impact of that. We are encouraged by those initial results, and it's something that we'll continue to lean into on as we move into Q1 and beyond. I don't know that our customer has changed dramatically other than just the continued strength of the penetration of the casual and the athletic area, which we have been leaning into obviously on. But we wanted to do that just based on the fact that we did see a erosion in kind of our awareness. And so we wanted to continue to make sure that we were increasing our overall customer file as we move forward. We're still working through on next year with regard to balance of top of funnel marketing as well as performance marketing. And just knowing that there's a latency impact, obviously top of funnel investment.

Gabby Carbone

Got it.
And then just a follow up, I wanted to dig into casual athletic a bit more. I think you mentioned last quarter that Nike came in about a month earlier than you originally planned. Maybe just how does the flow of Nike product transpire? How has the customer response been? And then has your other athletic kind of inventory competition changed at all with taking on more Nike product?

Douglas Howe

Yes, great question. Thank you. Obviously, we're very pleased with the initial Nike results on pure content and the product did come in a little bit earlier than we originally anticipated, which was originally planned for Q4. And so it was about midway through the quarter where it started to flow in the initial reaction has been quite strong within the first few weeks. It's on we now become one of our top five brands handily, and it still represented just a little over 1% of sales for the quarter, obviously. So we're still ramping up. And, you know, in historical times that was between 7% and 8%. So very encouraged by initial results.
As we move through Q4, we continued to see really strong momentum in the overall athletic category, which again, is part of our strategy as we tried to de seasonalized our business moving forward.

Jared Poff

And then Gaby, one thing I would add, and I think we've talked about this as well. In addition to the Nike product itself that we're very excited to see resonate with the customer. We also feel that the loss of Nike's certainly impacted other brands and that people would find their way into DSW through Google searching or some other way of the Nike brand and ended up buying somewhere else. Hard to quantify the exact impact of that. But we definitely think that that was a drag on our overall digital demand after we lost Nike across other brands. So we've been seeing that also come back. It will take time and the algorithms have to pick it up and bring you back to the top, but we're excited for what that might mean as well.

Gabby Carbone

Great.
Thank you so much.

Operator

Again, if you have a question, please press star then one next question comes from Jay Sole of UBS.
Please go ahead.

Jay Sole

Super, thank you so much. And you mentioned that you expect some of these macro pressures to persist for a while. You obviously don't have a crystal ball and I would expect that. But you what would you think the macro pressures might alleviate some of this glass into first half of next year?
Or I mean, how do you think about it?

Douglas Howe

P.j., this is Doug.
Thanks for your question.
Yes, your point we don't have a crystal ball. I would say kind of what we're seeing in Q4, which we've incorporated in our guidance is consistent with what we saw in Q3. There definitely was an outsized impact. We saw, obviously, in seasonal. We think partially attributable to warmer weather as we move into spring and that pivots into sandals.
Obviously, our assortment dramatically changes.
And we also we're seeing, like I said, buoyancy with the athletic trend and we're being very opportunistic and chase into inventory there to take advantage of what the customers are looking for. Having said that, I would say on customers continue to be very choosy and very selective with regards to discretionary purchases. And I think our clearance trend kind of indicates the fact that customers are still looking for value. That's always been a core strength of specifically DSW. We'll continue to lean into that on, but we're conservatively planning it and we'll be in a position to react and reacting to it real time.

Jay Sole

Got it.
And maybe, Doug, just to put a finer point on it, can you just talk a little bit about how the sales trended, say the week before the Thanksgiving weekend and then obviously through Cyber Monday, how sales trended and what you've seen sort of since then the week post that, I mean, did you see that spike? And then like last week as it had been noted normalization back to the sales growth rates that you saw for or you give us maybe a little bit color around that, that would be helpful.

Douglas Howe

Sure.
Yes.
Thanks for your question. We were very promotional because we wanted to make sure that we didn't lose share specifically as we went into that Cyber Week. And so we were very aggressive on promotions.
We did see a nice performance there.
And so again, you know, kind of mission accomplished with regard to not losing share. Having said that, there definitely has been a little coming out of Cyber Monday and then even the continuation of those from promos through Tuesday. So there's four weekends between Thanksgiving and Christmas. There's always historically been a bit of a lull between on Black Friday and the holidays, and we're definitely seeing that on. But what we're seeing, obviously for the quarter is still and is obviously incorporated into our guidance, but I think customers are waiting to the very last minute. They're being very selective. As I said, we were pleased with what we saw coming out of Black Friday, but again, we were very promotional and leaning into that.

Jay Sole

Okay.
And then if I can ask one more, if you just elaborate a little bit on the brand portfolio within the brand portfolio, which brands do you see the most strength, maybe which brands you know, is there room for improvement? If you could just touch on the brands within the portfolio, maybe would be helpful.
Thank you.

Douglas Howe

Yes.
And as Joe said in his comments, I mean that brand portfolio largely on performed within our expectations. We were up against a pretty strong comp last year as it relates to just some timing opportunities. But we're very encouraged with what we're seeing. Certainly from the card business, we're very encouraged with what we're seeing from turbo on two acquisitions, obviously, that were part of our strategy to down distort towards the casual line athletic space. So we're very encouraged by that. Again, small businesses overall, but we're definitely encouraged by what we saw and the plans that we have going forward for those brands in particular.
And then on Eliquis Grab, we launched that at DSW as part of our opportunity obviously to expand encouraged by initial results there as well. So again, early days going through, obviously the integration, but we're optimistic about those.

Jay Sole

Got it. Okay.
Thank you so much.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Doug for closing remarks.

Douglas Howe

In closing, I would be remiss not to mention the terrible tragedies that have unfolded in Israel and Palestine over the past several months. Our hearts and prayers are with those suffering and we recognize this is a very difficult and uncertain time for many of our associates, our partners and our customers.
I'm proud of how our team cares for supports and lift those around us.
We recognize the values that unite us have powerful positive impacts because at designer brands, we all belong. Thank you.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.