Good day and welcome to the Designer Brands, Inc. Second Quarter 2020 Conference Call. All participants will be in listen‑only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Stacy Turnof with Edelman, excuse me. Please go ahead.

Good morning. Earlier today the company issued a press release comparing results of operations for the three months ended August 1st, 2020 to the three months ended August 3rd, 2019. Please note that the remarks made about 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 Roger Rawlins, Chief Executive Officer; and Jared Poff, Chief Financial Officer. Now, let me turn over the call to Roger.

Good morning, and welcome to Designer Brands' second quarter fiscal 2020 earnings call. I want to start off by thanking our teams for their continued efforts as we manage through a gradual reopening of stores that was completed on July 12th. This has been an overwhelmingly challenging time for our industry, but I am confident in Designer Brands' playbook to strategically and successfully navigate the current environment. We will continue to execute against our strategic pillars of delivering differentiated products and offering differentiated experiences to drive growth. Importantly, we continue to uphold the highest safety protocols in stores, including increasing cleaning, supporting social distancing, monitoring the number of customers in our stores, creating safe try-on areas, and requiring all customers and associates to wear masks in every one of our stores. We have and will remain focused on prioritizing the health and safety of our employees and customers. We continue to employ best-in-class safety measures in our stores, including providing PPE to our customers and employees. Equally as important to us, is the long-term health of our business. In the second quarter, we took significant actions to protect ourselves amidst this uncertain environment, including greatly improving our liquidity position, instituting cost controls, and aggressively rightsizing inventory through markdowns and aligning inventory and consumer demand. We also narrowed our focus to the top 50 brands in footwear and reduced points of distribution for Camuto-produced brands, all while supporting our communities through our charitable and diversity and inclusion initiatives. We remain acutely aware of our responsibility to support our communities during this time. As we discussed last quarter, we have teamed up with Reebok and long-term partner, Soles4Souls, to provide over 100,000 pairs of footwear to essential workers and families impacted by COVID. As of the end of this quarter, we have…

Thank you, Roger and good morning everyone. Our second quarter continued to be materially impacted by COVID-19. Over the past six months, our team has taken numerous steps to run our business most efficiently as our industry and our economy work to recover from the first waves of the virus and to prepare ourselves for long-term success. Please note that the financial results that we will reference during the remainder of today's call excludes certain adjustments recorded under GAAP unless specified otherwise. For a complete reconciliation of GAAP to adjusted earnings, please reference our press release. First, I will share the steps we have taken from a liquidity and cost perspective in more detail and briefly discuss our second quarter results. Last month, we took additional actions to bolster our liquidity. We retired our $400 million revolving credit facility and entered into a new $400 million five-year asset-based revolving credit facility. This ABL revolver provides more flexibility to maneuver through this changing consumer landscape. Along with the new ABL, we entered into a new financing arrangement, which included a new senior secured loan. With a support of Sixth Street, in early August, we announced the closing of a $250 million senior secured loan to further support the ongoing needs of the company. Finally, we also want to remind you that in May, we suspended our dividends and share repurchases and given the terms of the liquidity agreements I just described, we will continue to forego these. Since February 1, 2020, we have drawn down $203 and currently have approximately $214 million available for borrowing. We are comfortable with our balance sheet position and ended the second quarter with $206 million in cash. We continue to lower our capital expenditures significantly. During the first half of fiscal 2020, CapEx was $22.1…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Sam Poser with Susquehanna. Please go ahead.

Hi. This is Will on for Sam. Thanks for taking our question. I wanted to ask, are you guys seeing any benefit from Nike's decision to continue to turn their wholesalers. I mean, are you seeing any improved availability of product or improved allocations?

Well, we've had lots of conversations with these top 50 brands. And what I'm really excited about is how all of them are sharing their interest in partnering with us, and that is both with their in-line assortments. It's with the special makeup opportunities and with closeout product. And I think what we're seeing from every one of those brands is they're excited because we have 30 million rewards members with roughly 80% of them being female. So, that's a customer that those brands are targeting And when you add in there that we are so underpenetrated in men's, specifically in athletic, they have growth potential with us. So, I think those things all combined for each of those brands is why those brands have ultimately decided to invest more heavily with us.

Got you, that's helpful. Thank you. And then, I guess, can you frame out the promotional environment going forward for you guys? And I know you said that you cleared through the vast amount of seasonal and dress product. Can you just -- can you frame how -- what it looks like over the balance of the year? And just -- and also with that, the marketplace as a whole, what are you seeing out there from a promotional standpoint?

I mean, I think probably what I'll do -- I'll just give you sort of a sense of how things are performing for us as we're not going to get into the detail of Q3, but sort of our game plan. And when you look at how we have flexed this business model as we go through fall to really focus on athleisure and this comfy cozy look is how we're describing it. We're seeing that our athletic business is running positive comps and driving margins a couple of points higher than last year. Our athleisure assortment now is representing 50% of our sales versus 35% last year and running margins greater than last year. And our kids business is steadily improving and we think back-to-school is going to be an elongated back-to-school period. And I think as we've steered away from career and dress wear and the early reads we're getting around trail and booties, where we are investing for fall, and the fact that we have our inventories, as we headed into fall, down 37%, we're looking optimistically about how fall can play out. I mean, we can be in chase mode and we are invested in areas where we're seeing the consumer respond. And that's the approach we're taking. And yes, people are going to be promotional. But frankly, we don't have a lot of that product to promote because we dealt with it in the first half.

Yes. And one thing I would add to that, and we are very excited with what we're seeing in the categories that we've pivoted towards, and as Roger said, we're about 50% in those categories that are doing well. That still does leave though, the 50% that you heard the kind of trends we're seeing on those other ones. And so as you guys are looking at your modeling, you've just got to balance that accordingly.

Our next question today comes from Rick Patel with Needham & Co. Please go ahead.

Thank you. Good morning and hope everyone is well. A question about the kids segment. So, nice to see the penetration increasing here. But can you talk about the outlook for the back half in light of the new back-to-school paradigm that's going on? I think you mentioned that kids and athletic would be up double-digits this fall. Just hoping for some color on just the kids part. Roger, you mentioned that you expect an elongated back-to-school season. I'm curious if that means that you expect sales to accelerate from where they are right now or whether you expect them to be consistently strong throughout.

No. I think -- well, I'll give you a data point. I think we get this NPD data that we're able to track to, and this is why I'm excited and why we got into kids. In July, what we were able to see was that we performed about 20 percentage points better than other shoe retailers in the kids category. And that's why that penetration continues to increase. And what we're seeing is that this is going to last, I would describe it as sort of four weeks later. And in markets where we have the kid going back-to-school, meaning they're actually walking in a classroom. We're performing in line or better than last year and doing what we'd expected. Markets where it's sort of a hybrid aren't performing as good as the ones where they're in school and then the ones where they all stay home. Obviously, it's no different than all the other social activities that if people have historically gone to church or to school or whatever it is, those folks that aren't performing those activities, they're not buying shoes the same way that others are. So again, I feel good about how we've positioned kids and our performance. But it will be a longer window of time to get that selling. That's what we're seeing.

And I know there was intra-quarter volatility given spikes in the virus in some of the big states. Can you talk about how much of a negative impact this cause in the second quarter? And do you expect these affected states to catch up to the rest of the fleet this fall or do you expect continued volatility going forward?

It was -- we talked about this on the Q1 call that as things were ramping back up and stores were getting opened, we were seeing in those, let's call them, I say, mature markets, meaning they had been open for five or six weeks, where we were in that minus 20-ish kind of comp range in stores, while digital continued to grow in the 20% to 30% range. And what we have experienced is, as those different markets get hit, we fall back to the minus 30 to minus 40 range is what we’re seeing. I think the area where we have been hit harder, I think, than some other retailers is we heavily penetrate some major markets. New York metro is a big market for us. D.C. is a big market for us. Philadelphia is a big market for us. And those are areas where this thing has hit us harder than others. And for example, in some of those markets, we're -- we've been down in the 70% range, while the balance of the chain is in the minus 30-ish range and/or better. And that's the area where we need to see some kind of improvement in those major markets, frankly, for store traffic. It doesn't mean we still can't sell the you-know-what out of digital opportunities. And we can't go get some amazing closeout buys that are attractive to those kind of markets that we can sell online. So we're looking for other ways to engage customers in those markets. But those are the biggest headwinds, I would tell you, that we face.

And our next question today comes from Tom Nikic with Wells Fargo. Please go ahead.

Hey, good morning guys. Thanks for taking my question. I hope you’re doing well and staying safe and healthy.

Thanks, Tom.

I wanted to ask about the digital performance. There was a pretty stark difference between what you achieved in the DSW banner, which was good, and then the Canada growth, which was far stronger, much better. Like why was Canada so much stronger than the U.S.? And I guess, if there's any sort of -- is it category mix? Is it anything like that? I'm just trying to figure that out.

I would tell you one. Mary Turner right now is smiling. She's the leader of Canada. But there's just significant differences in size, is what I would tell you. When you're running a $1 billion digital play that's been around for 12 years versus one that is fairly new and does not penetrate nearly as large as what we do in the U.S., that's one big piece. And would tell you is, Tom, I think I'm actually really proud of the performance we had in dot-com in the U.S., growing at 27%. But we mentioned this in the script that transactions were actually up 40%. But we really leveraged that channel this quarter to liquidate goods because we didn't have customers walking into stores. And so we went after the non-athletic space in a big way. And I would tell you, if we would have had -- if we'd have known a pandemic was going to hit and could have invested in athleisure inventory the way that some of our competitors are positioned already in advance, right, I'd tell you, we would have done a hell of a lot more business in dot-com, I mean a lot more business because, we did not promote dot-com for an athletic standpoint. We've been able to sell that stuff at regular price, and I think that's actually helping us in a big way. We're not running buy one get one on all these athletic brands. And I'm so excited about that. And that's why as we think about the fall and go forward, these brands are doubling down with us because they see we can sell their product without having to discount. And even some of those brands for this fall, we're going to test through our digital channels being able to sell some curated apparel assortments within those brands because we do not have to discount to sell athletic product. And I think that is going to help position us longer term with those brands.

Got it. That makes sense. And just a quick clarification -- I'm sorry I may have missed it. I think you said what the overall inventory receipt plan was for the back half. Can you just sort of run that by me again?

No. Tom, we didn't. I mean, we're entering fall down 37%, and we are investing heavily in the athleisure product. We are investing heavily into -- I keep calling it comfy cozy. It's hard. I need to show you photos to get you to understand what I do. But think of it as you could sit on your couch in these shoes or you could walk through your mailbox in these shoes. And that's essentially the way that I'd describe it to our team. And we're getting after the bootie business because we're seeing strength in trail in those kind of categories. But outside of those categories, we're going to stay extremely lean in inventory. And we will chase it when the consumer gets more comfortable going back into those settings where that where that product is relevant.

Got it. All right. Thanks for taking my questions and best of luck for the rest of the year.

And our next question today comes from today comes from Gabby Carbone with Deutsche Bank. Please go ahead.

Hi, good morning. Thanks for taking our question. So with inventory meaningfully reduced going into the third quarter, just was wondering if you could provide any additional color on how gross margin could play out for the remainder of the year. What do you view to be some of the biggest headwinds? And where do you see opportunities for improvement?

Yes, Gabby, I think, again, in that athleisure space where we're trending above last year, that's roughly half of our assortment. That's very positive because, we cleaned up the non-athletic inventory in a way that we feel we're in chase mode. I think we will still face some challenges simply because, in fashion, it's more challenging right now. And the fact that last year, we were growing in a material way, our exclusive brands. And we've stepped back a bit on that simply because we want to invest more in these top 50 brands for now. And then also, obviously, some of the shipping, as we grow dot-com, which we anticipate continuing to kind of track we were on through the first half, some of those shipping challenges will ultimately impact our margin rate as well. But in general, we anticipate being closer aligned to where we were in the back half last year.

Yes. The only thing I would add to that, Gabby, is -- and I mentioned this in my script, that merchandise margin Roger is talking to, we do anticipate with negative sales of any sort, you start to deleverage. And we do have our fixed cost occupancy in our gross profit calculation. And obviously, the increase in digital penetration, you've got associated shipping.

Got it. That's helpful. And then just a follow-up. When it comes to store optimization, how are you thinking maybe your U.S. store count, given the strong shift to digital? And then I know using your stores as athletic centers has been a priority. Maybe if you can just talk a little bit more about that. Thanks.

No, I think we're going to continue to lean into our warehouses and operate them as warehouses. And we're putting more and more product closer to the consumer in those warehouses so that they have the ability to buy it when they're physically there as well as being able to ship it within, hopefully, at some point here soon, a couple of hours to their doorsteps. So, I think that is -- that's been rooted in our strategy for years. But as it relates to the sort of the real estate portfolio, we're looking at many ways in which we can cut costs. And I think looking at that portfolio and having honest conversations with our landlords about the position of the business and ensuring that they're going on that journey with us, and if they don't, then we will be looking at -- if it means we have to exit some locations, we will do that. We've been lucky enough to-date we've not had to do that because the landlords have worked with us, and we're actually happy with the kind of percent rent deals and other things that we've been getting on, on some of the deals that we've recently struck. Jared, I don't know if there's anything else you'd add.

No, the only thing I would say is we partnered with a consulting firm, A&G Realty. The deferral work was great. And we -- as I mentioned, we've reached negotiation -- reached deferrals on almost all of our landlords and leases. We are actively now talking about rent reductions. And Roger mentioned it, where we have lease events happening, i.e. there's a termination or kick out, we have been able to successfully move to a percent of sales formula that is well below where we were pre-COVID. Even though it was fixed, when you look at it as a percentage of sales, we're well below that. We are aggressively going after that. And there are some, even without a lease event, that we need to have that kind of partnership. And A&G is out there right now, leading that discussion, and we'll have to make some tough decisions, but we think we've got some good opportunity.

Great. Thanks for all the color. Best of luck.

Yes, thank you.

[Operator Instructions] Today's next question comes from Chris Svezia with Wedbush. Please go ahead.

Good morning everyone. Thanks for taking my questions. I hope you all are doing well.

Thank you.

I guess first, Jared for you, I appreciate cash is king here and your comments about possibly positive free cash flow in the second half. But I was wondering just kind of given the puts and takes of the model, do you feel like you'll be profitable as a total company in the back half of the year? Or any color you can give us just based on some of the parameters you gave about sales, to some degree, margins, things of that nature. Just how do we think about profitability in the second half of the year?

Yes. Obviously, I'll start the conversation with we don't have the visibility to provide guidance. But when you do look at what we've given color as far as continued sales pressures, so while we've got some great sales tailwinds with the pivot towards athletic, athleisure kids, comfy cozy, as I mentioned, you still have the other half of the business, which is down 50%, 60%, 70%. And when you look at that, you couple it with our fixed cost infrastructure of the leases and just general cost and the margins that -- the margin dollars that don't flow through when you don't have those sales, I think it could be challenging to get to profitability in the fall. Not impossible. And if we see the trends, we think that there's certainly opportunities to do pretty well. But with current trends, I think that could be a challenge. All that being said, we've got about $50 million of expense, fixed expense and depreciation and stock comp in the fall that is non-cash-related. And so when you look at that, coupled with the work we've done on working capital, that's where we said there is possibility to still generate positive free cash flow.

That's helpful. Thank you. And I guess, Roger, for you. When I think about -- if I kind of step back and look at the acquisition that you did, Camuto and its original intent, and obviously, I can appreciate sort of the comments of where the consumer is right now and how they're spending and sort of putting the private brand penetration on hold, but how -- I mean, it seems like that may last for some time into next year, these trends we're seeing in the market and athleisure. So I'm curious how do you think about the operating cost model of the Camuto infrastructure. And are you at a point right now where it's leaning up? Or is there additional action that could be taken? Or where is maybe light at the end of the tunnel for that strategy that you had put in place, call it, two years ago or so?

Yes. Thanks, Chris. I mean, as we've talked about this, we bought it to provide differentiated products for our retail channels. And I think that is the focus of the business. And I was really happy with how the product looked and what we had built from a spring assortment standpoint. And I think this -- to just frame up, 95% of what we sell is something that, ultimately, we control through our own direct-to-consumer experience. So the challenge we are faced with right now with Camuto is more on that 5%, which is the wholesale side. And we've got to work hard to do a better job of either growing sales or finding a way that we have to cut back our SG&A. And that's work that we're in the middle of. And I think I'll give you an example of some things we've done recently with these -- some of these latest changes in our org, we shut down roughly about a dozen brands that, frankly, we just didn't see progress in. And we are going to focus our efforts on Vince Camuto, on Jessica Simpson and Lucky because those are three great brands that we know we can grow with our retail partners as well as within our own retail outlets.

Okay. Okay. But I guess, just final follow-up on that, do you expect next year to start to ramp up again the private label initiative? I know you launched Mix No. 6, relaunched it again in the stores this year, but I'm just curious, the kind of the runway as you start to think about it next year to start to build back up again. Or is it still completely off? And I'm just curious from a cost perspective, are the operating costs embedded in that business where they need to be? Or is there more potentially can get done there to streamline that operation?

Our goal when we acquired the business was to get to 25% to 30% of our business being through our exclusive brands, let's just say, Camuto-produced brands. And I don't think that plan has changed. I think the -- reaching that milestone is going to going to be out longer than what we had originally anticipated. Obviously, this whole pandemic impacted that in a material way. But again, we have to have differentiated products to support our long-term success. And I think the best approach to that is leveraging all the data we get from our selling channels and acting as a vertical retailer to be able to bring those goods to life for our customers. And when you think about how exclusive brands is going to play out in the next 12 months, we've cut back our production levels in exclusive brands by about 70% for the balance of the year. But our plan is to get back in spring of 2021 to be something penetrated closer to where we were in early spring of 2020, which was in that 10% to 15% range. So that's where our efforts are focused. And then again, growing Vince, Jessica and Lucky and we will address the SG&A in the event we don't see the kind of progress that we need over the next year.

Okay. Got it. One final just quick thing for me. Just on the taxes, Jared, just a clarification. I know many years ago, RBI, DSW, there were net loss carry-forwards that benefited DSW when the companies were combined. Is that how I'm looking at these tax losses? Do they just benefit cash flow, but on a reported basis, your tax rate is still, whatever -- we'll say, 27%, 30%? Is that how we should look at this? It's a cash flow benefit for 2021?

Yes. Yes. So I mean the cash flow benefit in 2021 that I'm referring to is really all of the losses that we are generating this year. The CARES Act is giving us the ability to go backwards over the last five years and apply these losses to those last five years of taxable gains. That's a special exception. They had changed the rules that you had to only apply them go forward. But that CARES Act is allowing us to go backwards up to five years. So that's why we are anticipating a very sizable cash tax benefit. I will say, as we look at the year in totality, you could see some lumpiness in our effective tax rate and that's really just a matter of you can only look at -- you've got to look at the last three years. And if you had a cumulative loss, then you've got to take valuation allowances against that. And we aren't there yet, but there's that possibility, depending on what happens in the fall, you could see some real craziness shake out with the tax rate. It's all on the balance sheet, and the cash is going to come in regardless. But that's -- just a little precursor of some craziness we're looking at for the fall.

Perfect. Okay. Sounds good. Appreciate it. All the best. Thank you.

Thank you.

And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.

Again, I know we have a lot of our associates listening on this call. Thanks for everything you're doing and let's get after it for the fall season. Thanks, everybody. Have a good day.

And thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.