Designer Brands Inc. (DBI) Q3 2020 Earnings Report, Transcript and Summary

Good day and welcome to the Designer Brands, Inc. Third Quarter 2020 Earnings 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 today's event is being recorded. I would now like to turn the conference over, to Stacy Turnof with Edelman. Please, go ahead.

Good morning. Earlier today, the company issued a press release comparing results of operations for the three months ended October 31st, 2020, to the three months ended November 2, 2019. Please note that the 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 Roger Rawlins, Chief Executive Officer and Jared Poff, Chief Financial Officer. Let me now turn over the call to Roger.

Good morning, and welcome to Designer Brands' third quarter fiscal 2020 earnings call. Thanks for joining us. We hope everyone is staying healthy and safe. I'd like to begin by expressing my gratitude to our employees and customers for their continued devotion to Designer Brands, during these very difficult times. As COVID cases rise across North America, we continue to prioritize the health and safety of our employees and customers, through our stringent sanitization protocols. Anyone entering the store is reminded that, masks are required inside. This has enabled us to continue operating without interruption, since the gradual reopening of our stores that was completed this summer. We are also cognizant of the impact this pandemic has had on our communities. As discussed in previous quarters, we partnered up with Reebok and Soles4Souls and have donated over 3 million shoes, as of the end of the third quarter and have provided over 130,000 pairs of footwear to essential workers impacted by the pandemic. We've also spoken to you in recent quarters about our plans to increase our focus on diversity, equity and inclusion within our organization. We are proud to say we brought in a new leader of this area in early October. And she is already hard at work on everything from recruiting and training to employee engagement and building the foundation for a cultural assessment that we will launch in early 2021. We look forward to providing more detail on these efforts in the coming year. Turning to our business performance, an uncertain economic environment continues, and we remain focused on stabilizing our operations to align with current consumer demand and behaviors. Historically, Designer Brands is known as a dress and seasonal house. However, as most people are still working from home and consciously avoiding gatherings and social occasions, these two categories remain very, challenged. As such, we continued our aggressive shift toward the categories and brands our customers are buying. We have been successful with our pivot to carry more athletic and kids product in the U.S. And today, we are more deeply penetrated in the top 50 brands in footwear, as our customers continue to favor buying products from names they trust. During this time, top brands are not just winning, they are outperforming. Because of this success, we are optimistic about the future. In the short-term, we plan to keep pivoting our assortment to align with consumer preferences. Long-term, there will be a day that our customers feel comfortable going out to shows, church and social events. When that time comes, we believe Designer Brands will be positioned to serve their needs better than any other footwear retailer. As we lean into the flexibility of our business model, and assortment and adapt to the new environment in the near-term, I'd like to address our assortment strategy for DSW in more detail across athletic and athleisure, kids, and the top 50 brands in footwear, as well as what we have achieved to-date. We've also detailed our efforts to pivot our assortment in the infographic that can be found on our Investor Relations site. Athleisure product is dominant in the footwear space this year. By our definition, athleisure includes all athletic product, as well as footwear inspired by athletic looks that is suitable for wearing outside of the gym and even at the office. In 2019, 52% of all footwear sold across the industry in the U.S. was women's and men's athleisure. In that same time period, 32% of DSW's U.S. sales were women's and men's athleisure. Even prior to the onset of the pandemic, we saw this as an opportunity and began shifting our assortment accordingly towards athleisure in the U.S. Over the past few years, our athletic vendors have expressed to us a desire to partner with retailers who have a strong market share with the female athlete, leading omni-channel capabilities and the ability to sell both footwear and apparel. When we met with these partners back in 2019, we emphasized our market share position and award-winning omni-channel capabilities, they listened. And we began our move toward including more athletic fashion in our assortment. When the pandemic hit, the consumers desire for this type of product accelerated. And our competitors, who have the history of playing more heavily in this space, have reaped the benefits. Likewise, as consumers have focused on this athleisure look, our pivot is paying off. By the end of the third quarter, we had grown the athleisure department to 49% at DSW, well above our seasonal penetration of 28%, which has historically been a much larger part of our business. According to NPD data, we are currently the second largest retailer of women's athleisure in the U.S., trailing only one small company called Nike. Our performance metrics in the U.S. retail support the increased penetration in athletic, with athletic comps up 5% for the quarter, significantly better than non-athletic comps that were down 40% during the same timeframe and even stronger than last year's level of 4%. Margins in the category are strong, up roughly 300 basis points versus last year, while margins in non-athletic are down over 600 basis points. We are proud of the fact that we can sell the best athletic brands at regular price without all the promotional activities that damage the reputation of athletic brands. And we make it clear to our partners that our strategies and margins will improve the long-term health of their brands versus selling through these promotionally focused retailers. Kid's also has been a bright spot for our business. Earlier in our history, we began selling kid's shoes, because we saw an opportunity to better grow our female customer spend once they had children. Today, kid's represent 10% of sales, above last year's level of 7%. This category has been climbing fast and performing well. During the third quarter, kid's comps were roughly flat, well above the total company comp with healthy margins up 117 basis points versus last year. In 2017, athletic and kids combined represented only 21% of our assortment. That grew to 22% in 2018 and 24% in 2019. It now sits at 36% at the end of third quarter 2020, a significant increase from three prior years. The pandemic has had a lesser impact on the kids category. Kids continue to grow, and replacing shoes is more of a necessity. This has helped drive the overall strength of the kids category. Turning to the top 50 brands. Our strong partnership with key supplier partners is a strategic differentiator for Designer Brands. The top 50 brands in footwear recognize our nimble business model, command of over 30 million rewards members and our status as one of the largest retailers in footwear. We have honed our focus within the 50 brands and specifically, the top 10 brands over the past year. Based on our research, we continue to see consumers searching for brand first and then a specific type of shoe. Customers are buying products from brands they know and trust. The top 50 brands of footwear comprised 73% of our total assortment in Q3, compared to 65% last year. Within those, the top 10 brands represented 38% of our total assortment in the quarter compared to 32% last year. We continue to build relationships with these key footwear vendors, including luxury brands, and wanted to highlight work we did with Gucci during the quarter. For a limited period of time, we offered over 100 SKUs with a focus on sneakers. This resulted in $13 million of incremental demand in Q3, and we are selling products at over 10 times our normal AUR. Importantly, in total, our efforts to reduce inventory exposure and focus on athletic, kids and the top 50 brands in footwear contributed to our overall merchandise gross margin rate for U.S. retail improving a 100 basis points when compared to the same period in 2019. Clearly, additional opportunity exists as we increase our men's and women's athletic penetration even further and drive incremental purchases for children and other family members. Looking ahead, we're continuing our aggressive increases in athletic penetration and currently have access to the highest level of inventory possible based on the product made available to us so far by the top national brands. Recently, we finalized inventory decisions for our spring selling season and did so under the assumption that the world will look largely similar to the environment we are experiencing this fall season. Based on these dynamics, we are remaining conservative with our buys this spring, as we continue to face significant challenges from COVID-19 and do not expect demand trends to change materially from the current environment. However, we are planning for athleisure comps to grow double-digits in the first half of 2021. We've also been putting into place new measures to increase flexibility. We have adjusted our partnerships with key suppliers in order to get first access to more product in the event that the market normalizes quicker than expected and the demand for dress and seasonal footwear ramps up compared to our current assumptions. This coupled with our ability to source dress and seasonal product ourselves through our Camuto segment, means we can get product in our stores at a shorter run time of four weeks to six weeks rather than the nine months, it can take to get fresh branded product. Turning to our Canadian operations. Canada continues to deliver a relatively better performance with comps down 19% for the quarter. As we have stated in the past, our Canadian operations already have a much higher penetration of athleisure and kids product, which has provided a buffer for the business throughout 2020. We are using best practices and learnings from our Canadian business to understand consumer behavior during the pandemic and inform the successful pivots we are making in the US. Now I'd like to discuss our Camuto business, which remains challenged as the majority of our product produced by Camuto falls into a traditional dress or seasonal category. We continue to see a lack of customer demand for these products at our DSW stores as well as our wholesale businesses. As a result, we have taken steps to ensure inventory is aligned with that reality and decreased wholesale production at Camuto by 40% during the third quarter. Looking towards the fourth quarter, we plan for production to be down 30% versus last year based on the trends that we experienced this period. We know eventually the market will turn when our customers are able to return to social activities and all will need dress and seasonal shoes. We must be patient and understand this impact is temporary, but we will be ready when the market changes. And given the work we have done to increase our speed to market, we expect to be able to jump on demand even faster once we see it materialize. So while we continue to anticipate similar pressures in consumer sentiment during the next two to three quarters, a return to normal will inevitably come. We will be ready to gain market share with our commanding lead in dress and seasonal product, in addition to our increased market share position in athleisure. And as such, we see a very exciting future for Designer Brands. And finally turning to digital. Digital will continue to be an incredibly important part of our business and we remain committed to investing in these capabilities. We continue to offer the digital services our customers appreciate, including buy online, pickup in store and curbside pickup and are proud of the fact that we were once again named the number one omni-channel footwear retailer for the third year in a row. It's not a surprise that the dynamics we are seeing online are very similar to in-store. Digitally, athleisure continues to drive significant increases to last year, while the balance of our assortment remains challenged. While we continue to be very proud of the digital capabilities we've built, we have a great deal of opportunity to build out more digital-centric experiences for our customers. Let me share just a few points about the success of digital in recent weeks. In the beginning of the fourth quarter, we surpassed 50% digital penetration. And over the Thanksgiving holiday week, 57% of our demand was digital compared to 38% last year with athletic comps up 18% over the course of the week. This highlights the strong infrastructure we have placed to support customers' desire to shop online, a trend we think will continue even when shoppers feel more comfortable shopping physically in stores. Now we have to turn our attention to differentiating ourselves even further from our competitors by continuing to elevate our online presence and capabilities. We are currently in the process of hiring a Chief Digital Officer, who will help us do exactly that. In relation to digital, I'd like to mention an unforeseen incident that occurred during the quarter with one of our third-party vendors, whose systems we use to route digitally demanded orders to our stores for fulfillment. The vendor experienced a ransomware attack that impacted its U.S. operations and subsequently shut down its systems voluntarily. This shutdown impacted services to Designer Brands in the U.S., and we effectively lost a portion of our digital sales capabilities for two weeks during our crucial Septober selling season. As of November 2, the issue has been resolved, and all fulfillment services are back online. However, the lost demand during these two weeks was certainly felt. And we are not anticipating it will be replaced, which is likely to lead to some unplanned markdowns in the fourth quarter. While plans are not finalized, we do expect the event to be covered by insurance, and we are working through that process now. We will update you at a later date, once that portion of the process is resolved. Overall, results in the third quarter notably improved from the second quarter. Our costs were down 30% compared to a decline of 43% last quarter and an increase of 0.3% last year. It's important to note that back in May and June, when we talked about seeing 8 to 10 points of improvement weekly in traffic trends, we were making decisions about our fall assortment. During that time period, we were also seeing early indications of some boot demand. We accordingly made the decision to invest slightly more into the seasonal inventory that was resonating with our customers. Instead of bringing boot inventory down 30% as originally planned, we increased our boot buys to align with the sales decline in the teens. In August and September, while we were continuing to see the steady improvement in consumer confidence in-store traffic, we also saw sales, specifically seasonal product, significantly outpacing inventory and aligning with our expectations. However, we have since seen significant reversals in consumer demand and traffic as the COVID resurgence has taken hold across nearly the entire country. Many major metropolitan areas are under stay-at-home advisories and the number of new cases weighs heavily on consumers' minds. Store traffic has returned to roughly down in the 40% range, as we experience a COVID impact similar to what we are hearing across the industry. This has been particularly severe in our top markets located in major urban centers. These key geographies that represent roughly 15% of store sales realized a negative 51% comp, with traffic down 46% in the quarter. Given the trends that we are seeing at the store level, we are focused on leveraging our digital channel to drive demand and utilizing our local warehouses to fulfill that demand and avoid markdowns. We are aggressively managing inventory to align product on hand with current demand trends. However, if the COVID resurgence holds steady or worsens as we move through the fourth quarter, we will likely need to take further markdowns on some of the seasonal boot product that we bought following the initial signs of demand we discussed earlier. Finally, although we are not typically a holiday retailer, we have leaned into the consumer's gift-giving mindset and set up gifting shops in all of our stores that include slippers, socks, blankets and scarves. We have positioned toy sections adjacent to the kids' area and included up shops in 100 locations that bring accessories, handbags and footwear together in the same section. There is no doubt that 2020 has been a difficult year, and pressure will remain in the beginning of 2021 as well. We've seen positive news on the road to developing a vaccine. But widespread adoption is still far off as we enter the coldest months of the year. And we're seeing a resurgence in COVID cases, as well as regionalized responses, including curfews, stay-at-home advisories, and in some cases, forced shutdowns. We have adapted both our product assortment and our omni-channel customer experiences and are prepared should we need to move to a digital-only operation again. We will continue to lean into athleisure trends and our liquidity position gives us the flexibility to continue operating in this difficult environment. We do remain hopeful based on the latest information surrounding vaccine trial, but given it will take time for broader distribution; we do not estimate a return to normalized customer behavior or profitability for our company until the back-to-school season of 2021. We will continue to operate in the same manner we have been in order to align our business with the current realities of the industry. We know we can make progress and have seen some of the fruits of that labor this quarter. With that, I will turn it over to Jared. Jared?

Thank you, Roger and good morning everyone. Our third quarter saw a sequential improvement across the business as we posted our strongest quarter year-to-date. We are pleased with our progress, but cautious as we look to the rest of 2020 and the beginning of 2021 with macro headwinds, specifically a resurgence in the virus already impacting our company. I want to take some time to walk through our third quarter performance. Then, I'd like to briefly discuss how we're thinking about the remainder of 2020 and 2021. Please also note 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. This quarter was still challenging, but we saw a notable improvement on a sequential basis across all key metrics, including comps, revenue, margins, and expenses. The improvement was led by our ability to navigate through this environment, focusing on increasing our penetration of athletic, athleisure, and kid's product as well as our actions to right-size our expense structure and manage our inventory assortment. We mentioned on a previous earnings call that we were being conservative on inventory and waiting to see demand growth in dress and seasonal. In the meantime, our efforts to lean into digital as well as athletic and kid's product helped us return to a more normalized merchandise margin rate. Additionally, we saw some demand return on the seasonal front, but unfortunately that was temporary as the COVID resurgence has been both swift and widespread. Moving to our results, for the third quarter, sales decreased 30.1% to $652.9 million, which included $21.6 million in intersegment revenue that is eliminated in consolidation. This was in line with our inventory position coming out of the second quarter. Overall, revenue improved notably on a sequential basis compared to the second quarter. In the quarter, total comps were down 30.4% versus up 0.3% in the same period last year, but a significant improvement sequentially from the down 42.7% in the second quarter. In the U.S. retail segment, comp sales were down 31.9% during the third quarter versus flat last year and also sequentially improved from the down 44.9% in the second quarter. We are pleased with the sales improvements that we saw during the quarter, driven by our initiatives to pivot towards the athleisure category and in line with our inventory position coming out of Q2. At the end of the third quarter, in U.S. retail, our athletic business represented 26% versus 17% in 2019. Athleisure, which is inclusive of athletic, represented 49% versus 34%. And dress and seasonal together represented 35% versus 48% in the same period in 2019. And as Roger mentioned, athletic and the broader athleisure categories produced positive comps during the quarter, well above our overall company performance and store traffic, which was down 38%. Conversely, dress and seasonal comped negative 60% and negative 44% respectively, reflecting the continuation of depressed consumer demand. We anticipate athleisure comps will grow in the double-digits in the first half of 2021, and we are looking to add product as aggressively as possible. During the quarter, we did see some pressure on our results, as we were impacted by issues outside of our control, namely the resurgence in COVID across the country and the ransomware attack experienced by our third-party vendor. Digital demand continues to be strong for DBI. In U.S. retail, digital demand comps improved through August and September, which increased – with increases of 16% and 22%, respectively. The rapid and strong resurgence of COVID across the country and the issue with our vendor during the last two weeks of the quarter resulted in a decline in digital demand comps of 22% for October, bringing the full quarter U.S. retail performance to up 3%, on top of a 45% increase last year, still well above our store performance. In total, we saw digitally demanded sales comp up 7% for all of DBI, which represented 35% of total demand versus 23% last the second quarter. In Canada, comps were down 18.7% for the quarter. This was a sequential improvement from down 27.9% in the second quarter. Despite the decline of stores, results were slightly offset by strong web growth, which was up 121% compared to the same period last year. As Roger mentioned, our Canadian operations were already more penetrated towards athletic and kids prior to the pandemic, which is helping that business perform better than our U.S. locations. Canada did experience unseasonably warm weather to start their critically important winter boot season, but at the end of the quarter, the weather started to turn cooler. This favorable weather, along with prescriptive promotional activity, will allow our Canadian operations to work through our boot inventory without taking significant discounts. Looking at casual and dress, these category sales were below expectations, and we anticipate some margin pressure as we work to clear through those SKUs. On a positive note, Canada has partnered with some big cold weather brands to expand assortment through the setup of cozy PJ shops and outdoor snow apparel areas in our stores and online. This is providing us with some incremental revenue. Let's turn to our Camuto Group, which is nearly exclusively a seasonal and dress business and thus remains in a very challenged position. Total net sales for Camuto, including sales to DSW, were $83.9 million in the third quarter, down 39% versus last year and sequentially improved from down 70.4% in the second quarter. Wholesale sales were $73.7 million in the third quarter versus $117.4 million last year, including sales to our retail segments, which totaled approximately $21 million versus $23.9 million last year. Commission income decreased 43.8%, including income earnings from our own retail segments on exclusive brand business, which totaled $0.6 million in the quarter. At ABG, we were able to take advantage of liquidation sales at Stein Mart to clear other inventory at a higher price than previously anticipated. Stein Mart is now completely shut down as of the end of Q3. And beginning in Q4, we will no longer report activity, in our other segment. We generated $165.7 million in gross profit in the third quarter, our strongest quarter year-to-date versus $273.3 million in the prior year. This decline was a direct result of significantly reduced customer traffic in our stores due to the continuing impact of COVID-19. As mentioned last quarter, with the inventory actions taken in the spring, we generated 100 basis points of higher merchandise gross margin rate in Q3, compared to last year at DSW. However, our consolidated gross profit margin continued to be impacted by COVID-19 decreasing 390 basis points to 25.4% in the third quarter versus 29.3% in the prior year, a sequential improvement from the prior two quarters, though. We are still experiencing elevated shipping costs given our strong digital growth and deleverage in fixed occupancy, supply chain and royalty costs, as we posted COVID-impacted negative sales comps. At our U.S. retail segment, we saw continued pressure on the retail gross margin, but an improvement over the second quarter. Margins were 23.4% in the third quarter versus 10.5% in the second quarter. Similar to the U.S. business, Canada gross margin in the third quarter was 30.7%, a decline of 530 basis points versus last year, but a sequential improvement over the second quarter. Camuto's gross margin rate was 26.4% in the third quarter versus 29.7% last year and also improved sequentially from negative 31.6% in the second quarter, as we reduced production to align with demand and cleared through the markdowns taken in previous quarters. Gross profit rates are traditionally lower in Q4 than Q3, as we deliver on various concessions with our wholesale customers. I want to spend a few minutes talking about our focus on inventory and the steps we are taking as we plan for the early part of 2021. We ended the quarter in solid shape. As a result of strong inventory controls, our consolidated inventory was down 19% in total versus last year. On a unit basis, inventory was down 17% compared to last year. Although, we saw sequential improvement across our business, demand remained depressed. I want to echo Roger's comments that, we are being as aggressive as possible an increasing our penetration to athletic and athleisure product and managing our inventory assortment as a result. We are also planning spring 2021, assuming that the macro environment looks largely the same, as it does today. We are not anticipating a return in demand for dresser seasonal product, but are taking steps to ensure we have maximum flexibility, if the demand environment changes. We are working with our supplier partners, particularly our top 10 to obtain first access to additional inventory, should demand levels recover earlier than anticipated. And we have Camuto at the ready to ramp up production for us as soon as we see demand materialize. Moving to operating expenses, in the third quarter consolidated adjusted SG&A was down 8% to $196.1 million versus last year. Given the significantly lower sales base, our SG&A rate was 30% of sales, above last year's level of 22.8%. In total, we reduced operating expenses by $16.8 million in the third quarter, in addition to the $43.9 million reduction in the second quarter. A large driver was our recent headcount reduction, partially offset by a bonus accrual reversal in Q3 of 2019 and increased marketing expenses, compared to last year. Depreciation and amortization totaled $66 million in the quarter compared to $64 million in the prior year. Adjusted operating profit for Designer Brands was a loss of $28.6 million in the third quarter versus a gain of $63 million last year. Interest expense was $9 million during the third quarter versus $2.2 million in the prior year. Moving to taxes. Our effective tax rate for the quarter was 49.4% compared to 20.2% last year. The significant increase in our effective tax rate is a result of the CARES Act, which allows us to apply this year's losses against prior year's income, which was at higher tax rates. We expect to see a notable cash tax benefit in 2021 as a result of the CARES Act. Looking forward, we expect our tax rate to remain extremely volatile, as CARES Act impact will be felt as well as potential valuation allowances being placed on expected future tax benefits until such time as we return to consistent profitability. Total weighted average diluted shares during the quarter were 72.3 million, compared to 72.9 million last year. We reported a net loss of $40.6 million, or $0.56 per diluted share, which included store impairment charges of $30.1 million, primarily related to stores located in urban areas. Excluding the impairment charges and other adjustments, adjusted EPS was a loss of $0.26 per diluted share for the quarter. We have taken a number of steps over the year to bolster our liquidity position and flexibility. We are comfortable with our balance sheet and ended the quarter with total liquidity over $400 million. This is comprised of $114.5 million of cash versus $87.8 million last year, and $295 million available to draw on our revolving credit facility. Our outstanding debt at the end of the period was $347 million versus $235 million last year. While COVID has had a material impact on our operating performance, we remain pleased with our liquidity, given the measures we have taken over the past year. We successfully refinanced our $400 million bank revolver and raised $250 million in incremental liquidity this quarter. We generated significant liquidity through working capital management, expense management and reduction in all non-essential capital expenditures. Today, we actually have more liquidity on hand than we had at the end of fiscal 2019. Finally, at the end of last quarter, as a backstop, we installed an at-the-market equity facility of up to $100 million, which could be deployed should conditions demand. We believe that Designer Brands has sufficient liquidity and access to incremental liquidity to weather the storm until we see consumer demand return to something normal. During the quarter, we opened four stores and closed two in the U.S., resulting in a total of 524 U.S. stores. In Canada, we opened one store with no closures, ending the quarter with 145 stores. With continued pressure, we are seeing on store traffic and the material acceleration we have experienced in the transition of customers from store to digital, we continue to closely evaluate our existing store infrastructure. While we are making some progress on lease concessions, the fact remains that our fixed cost store infrastructure is not nearly as productive as it once was. We anticipate that we will likely open very few to no new stores for the foreseeable future. And we will begin aggressively negotiating exits of our worst-performing store locations as lease terms and market conditions warrant. While this will be a gradual transition over time, it is likely we will look to close 10% to 15% of our store fleet, while still retaining a physical presence in most geographic markets, and of course, a strong digital presence. More to come as this work continues. I would now like to turn to our outlook. We are pleased with the sequential improvement we saw in the third quarter, but we are cautious as we look ahead as we are seeing the impact of a strong and widespread COVID resurgence. Quarter-to-date, our comps in the U.S. are down roughly 20%. Given the resurgence of COVID and the impact we have seen on store traffic, it is difficult to assess the trends. Keep in mind that we are not a big holiday destination and that seasonally, January is typically our smallest sales month of the year. Ultimately, we expect the balance of the year and spring will look largely the same as what we are currently experiencing in terms of consumer demand. On the sales front, we don't expect a significant improvement from Q3 until late spring or back-to-school of 2021. While we saw the merchandise margin rate normalize in the third quarter, we may see some gross margin pressure in the fourth quarter as we may need to take some markdowns to clear through some boots that saw their demand dry up with the COVID resurgence. However, the anticipated markdowns will not be nearly as severe as what we saw last spring. Additionally, if that traction in boots returns, then these markdowns may not be necessary. We are monitoring COVID cases daily by market and allocate product accordingly, so we have the right shoes in the right places to capitalize on demand. Our focus is to manage inventory levels to align with sales trends, so we are in good shape as we head into the first quarter. We will be reading demand results closely over the next few weeks. Given there is still a great deal of uncertainty, we are not providing official guidance at this time. Overall, as we look ahead, we anticipate our business will remain challenged until a vaccine is more widely distributed, which will not likely be until back-to-school season of 2021. We remain confident in our long-term strategy and our liquidity and flexibility that will help us weather this challenging time. With that, we will open the call for questions. Operator?

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.

Good morning, everybody. Thanks for taking my question. I've got a handful. I don't know if I'm going to limit my questions as much as you want. Happy holidays as well. Just a quick one on the conversation about the trends versus the first half of next year. Are you really talking about trends versus 2019? I mean, how should we think about that? It's kind of complicated because--

Yes, Sam, I think as we're running the business, it's really looking at the trend versus fall and comparing that to last year. So, that same kind of run rate that we're experiencing this fall is sort of how we're expecting spring to play out. If you think about it, our business is typically 50/50, spring/fall. I mean, it might be 49 or 48, but it's in that kind of ballpark. So that's the lens we're using to operate the business. Again, until there's some real clarity that that we can see where the customer is going back out and engaging in the social activities that we saw before this, that's the way we're going to run the business.

And then – so, we should think about spring down like 20% to 30% versus spring 2019 or I mean, that's what I'm trying to figure out.

Yeah, directionally.

Yes.

Okay. And then secondly, your athletic inventory versus – like where is your athletic inventory now relative to your sales? Your total inventory is in pretty good shape. How does the athletic inventory look relative to the rest of it?

Yeah. I think athletic, the assortment in athletic.

Athleisure, let me say athleisure.

Yeah. Okay. That's great. Yeah. No, we have consistently seen sales outpacing inventory. And that's why we feel very confident that we've got to continue to pursue this kind of opportunity. And as I said in the market share, I mean, we were 20 points below the market in penetration in this category. And it's been two years ago, I think, that Jim and Debbie and I had this conversation about, we've got to go – we're giving market share to people. We got to go get this. And that's exactly the approach we're doing. So that's why I really, really believe, we are positioned uniquely from everyone else in footwear that we've been out there getting this athleisure customer, which is our current customer, but also a lot of new customers. And when they go back to social occasioning, we will go jump on the business. And that's why I'm so excited about the work we've done in this space.

And then lastly, can you talk about the use of your CRM vis-à-vis the emails that you're sending out to your customers in your loyalty program? And I'm just starting to say, I mean, what are you doing to target those emails and rather than bombard customers with just lots of emails?

I mean, we segment emails by – there's groups of folks that get different communications. And right now, obviously, it's about boots, boots, boots. But our team has been able to identify, obviously, a male consumer from a female consumer from a family consumer. Those are all the approaches that we take. But right now, pretty much across the board, we are very, very focused on – boots is roughly half of our business. We've got to go – we’ve got to drive the boot business.

Got you. All right. Thank you very much. I’ll buzz back I’ve got anything else. Happy Holidays.

You’re welcome. Thank you.

All right. Bye-bye.

And our next question today comes from Steve Marotta with CL King & Associates. Please go ahead.

Good morning, Roger and Jared. If there are no major expectations for changes in consumer demand in the first half, can you talk a little bit about your expense strategies in order to manage, essentially the expense structure downward as much as possible in order to offset or partially offset that decline in demand?

Yeah, Steve. What I would say is the posture we have taken in fall, certainly will continue. Where we had some, I would say, deleverage in the fall was really only around marketing, as it related to pre-opening. And letting – it's not pre-opening, reopening and letting people know that our stores are reopened. I don't see that level of deleverage maintaining into the spring. All stores have been open. And then obviously, we had some bonus accrual reversal noise happening in the third quarter that all else being equal would not be there. Everything else, I see us maintaining the posture that we're at in addition to the benefit of the big rift that we unfortunately had to do at the end of July. So I think that when you look at Q4 specifically, what comes out of there versus LY from an expense dollar standpoint is going to be somewhat similar to Q1 and Q2 for next year. Q – Steve Marotta: That's very helpful. And can you elaborate a tiny bit on the digital issues around the vendor in October? Can you talk a little bit about maybe magnitude, quantify it a little bit? Did your digital operations cease for two weeks or was it in one particular very specific segment of the entire digital strategy?

Yeah Steve, thanks for the question. So I think you're aware that, that Septober window, that is our holiday season. And is really during the last couple of weeks of that season where we essentially lost access to the goods that were in our stores, which we call our warehouses. We lost visibility to those as if from a customer perspective. To give you a sense of normal business, we have about 13 -- my goodness, about 13 million units that are available visibly to the consumer through our digital channel. That number dipped to roughly about 1.3 million during those two weeks. So that gives you a perspective of when you lose access to that many units digitally, that's a big deal for us. But it was material to the third quarter. And as Jared had mentioned, we're going to go take every action we can to recover through our insurance policies the loss that we incurred. Q – Steve Marotta: And I just want to follow-up on that really quickly. How long do you think that, that process will take?

That's a great question, Steve. We are aggressively pursuing it. So we are knee-deep right now in the negotiation in the claims adjustment process with our carrier and our excess carrier. But as you may know, the most complicated part is the part around the lost business. Like the added expense is pretty cut and dry. It's the lost business part. So we're really hoping to get as much of that negotiated by the end of this year. But to be perfectly honest, I could see some of that slipping into next quarter. Q – Steve Marotta: Very helpful. Thank you so much.

Yeah. Thanks, Steve.

And our next question today comes from Jay Sole with UBS. Please go ahead.

Great. Thank you so much. Roger, as you think about the athletic business today and just the business is continuing focus on the top 10 and 50 brands, how high can the mix of one brand go within the store? You're willing to let one brand become 6%, 7%, 10% of total sales. How are you thinking about that right now? A – Roger Rawlins: Yeah, great question, Jay. And I do think looking at those top 10 brands, seeing one or two of them that can get up into that 5% or greater penetration, I think, is okay for us. If the customer wants to go there, we've got to go with him and her. And I'll give you an example. The biggest brands in the athletic space have been dropping department stores and grocers and online-only retailers left and right. And the more relevant we can become to brands like that and become a bigger player within their organization, given that the consumer isn't -- that brand is in high demand to the consumer, we're okay with that. And that's the approach we got to take. If our customer wants to go there, we've got to go there with them. And I think we had not taken that approach, frankly, over the last few years as the consumer had clearly gone to the athleisure space, again, with over 50% of the market in that space and we were playing around roughly 30%. And we've got to think differently as merchants and design team and that's the approach we're taking.

Got it. Okay. Thank you so much.

Thanks, Jay.

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

Hi, good morning. Thanks for taking my question. So you mentioned how customers are kind of more comfortable shopping brands they know. How does that kind of change your private label strategy in the long-term? Do you still see the opportunity to reach 25% to 30% penetration from Camuto-produced brands?

Yes, Gaby, great question. So I think we still see significant upside to be a vertical retailer. And finding what that right mix is, I think we've still got to define that. But is it still north of 20%? I think absolutely. And when you take out sort of the athletic piece, you take out some of the iconic brands; there is still a large chunk of our business. And again, I'm talking post-pandemic kind of lens. There's still a ton of business that we do outside of those two buckets that we have an organization that knows how to design and build the best dress and non-athletic footwear in the industry. And we've got to unleash that machine on that part of our assortment, and we will get after that, but we've got to do it at the right time. And I feel very confident in our team's ability at Camuto to deliver on that. I've got Debbie working in that area, who is in the shoe hall of fame and will deliver, because she has a history of doing that in her X number of years that she wouldn't want me to share at DSW. But I still feel very, very confident that being a vertical retailer in this climate to differentiate your assortment is critical to the long-term health of our business.

Got it. Thanks. And just a quick follow-up. I'm wondering if you can dig into gross margin a little more and kind of how you view that to play out in the fourth quarter. It sounds like markdown could be a large headwind, but where on the other side you kind of see opportunities for improvement?

Yes. So depending on what we ultimately have to take in markdowns, our merchandise margin could be flat, flattish to LY or down, I would say, probably 400 to 500 basis points. So that's kind of the swing. And it really is coming down to these next, I'd say, three to four weeks, which is still very big boot demand and especially if there was any that was waiting on the sidelines. So we'll see on that front. I still see -- there is no model on earth where I'm seeing positive comps for Q4. And by nature, that's going to drive some pretty significant deleverage on the gross profit or on the occupancy and fixed cost in the FCDC line. So all that flows through to gross profit. And then obviously, as long as our digital demand continues to really be the channel of choice, we will continue to see some pressures there on the shipping as well. So net-net, I think it's still some headwinds, but that markdown volatility is really what's the big unknown right now.

And, Gaby, I think the other piece, as it relates to margin go-forward as you think of first half next year, I think our team has done a really nice job of managing inventories to tie back the sales. And so I think continuing those kind of disciplines as we go through the spring season, primarily in the seasonal area, where we do not want to be out there beyond our skis on some of those items, which we have the ability to chase in a bigger way than we probably have pursued in the past based on the work our merchants have done. That's the area where I think, again, continuing to improve margins as we move forward from where we have been, that's where the opportunity lies.

Got it. Thank you so much. Best of luck.

Yes. Thanks Gaby.

And our next question today comes from Chris Svezia with Wedbush. Please go ahead.

Good morning everyone. Thanks for taking my questions. Hope, you're all well. I guess, just first, just to clarify, when we distill all the puts and takes as you see it for Q4, without getting too nitty-gritty, but is it fair to say the operating loss or the earnings loss could be greater than Q3, just given Q4 is seasonally a lower margin quarter to begin with and just sort of your comments about inventory exposure, et cetera, if I'm thinking about that correctly?

Yes. I mean, again, Chris, I think potentially, we've really got to see what happens on the markdown front. But overall, I think you're thinking about the calendarization the right way. Where I would comment where we're probably a little different than last year or historical years is I think, our topline might be a little more even between the two quarters this year. We just didn't have that same type of seasonal demand that we normally have in the October frame that really pushes that Q3 much, much higher. So, that's going to be a little more equalized. But overall, yes, I do think you're going to see a bigger op loss in Q4 than you did in Q3.

Okay. Thanks Jared. And just on that topic when you think about first half, I think, Roger, you mentioned this. I'm not sure. But first half of 2021, you're expecting still all else being equal, to generate operating losses and profitability. I think you mentioned back-to-school, so that's probably leaning into Q3. Am I thinking about that correctly, all else equal?

Yes, that's right, Chris. And again we are hoping that social occasioning accelerates and we will be positioned and are positioned to jump on that if it happens. But that's the approach we're taking, because as you know, it's all about how do you buy the inventory and so we'd rather maintain that kind of lens through the first half. And as you know, historically, Q2 for us has not been as strong as Q1 in the spring season and that's more of a window of when we're clearing seasonal goods. So, that is -- that's the lens that we've applied to the business for 2021.

Understood. One last quick thing here. Just on non-athletic categories, you mentioned athleisure being up in the double-digits from a comp perspective for first half of 2021. Just the other categories, broadly no change based on what you're seeing now? And what's packed away, if anything, that you have in your stores at this point that you'll bring back out for spring 2021?

Yes. So, Chris, the approach that we've been taking, it's -- in the non-athletic space, the trend on pumps, dress, any of those kind of items has really not materially changed since the pandemic started. And those have been in the down 50%, 60%, 70% range. And we're anticipating that kind of performance to continue in that non-athletic space. And as it relates to sort of the approach we're taking on packaways, yes, we do have some from last year that we can pull out, but not a significant amount as it relates to spring. But some of the work we're doing, is if you take a look at – let's just use a simple black pump that's on the floor today, there's no need to take a markdown on that pump and try and get out of that, so that we can go buy another black pump because the consumer hasn't bought it in nine months. So that we're literally looking item-by-item to decide, what are the things that it makes sense to take a mark on now that we know can draw a reaction from the consumer, versus things that will allow to, live for a longer period of time, knowing that it will come back at a later time, did that – hopefully, that answered your question?

No, that does. Thank you and all the best. And Happy Holidays.

Yeah. Happy Holidays, Chris. Thank you.

And our next question comes from Dana Telsey with Telsey Advisory Group. Please go ahead.

Good morning, everyone. As you think about the pivot with store closures and potentially more store closures, how do you think about the integration with omnichannel initiatives, whether it's curbside or BOPIS? What kind of store portfolio do you need? And also on the digital side, what are you seeing on the margins there? And how are you pivoting customers in digital to become multi-channel customers? Is that happening? Thank you.

Yes. Thanks, Dana. So one of the biggest competitive advantages we have is having 520-some in the U.S. fulfillment centers within 20 minutes of 70% of the U.S. population. And that is the preference, is I love the fact that we have the ability to deliver product to our consumers faster than anyone. We've got to bring that to life from a customer experience standpoint. And that's what the team is working on in 2021. And my team is listening to this call. So I want them to – I want to reinforce to them that is a strategic differentiator for us. And that's an approach we've got to take. As we look at digital experience, I think, as I had mentioned in the call, that hiring a new Chief Digital Officer, a position that we haven't really held in the company in the past is great – going to be great for us and bringing to life differentiated experiences. It's tapping into that emotional connection that we can create through our digital lens, which is trending to be north of 50% of our demand. We've got to continue to lean into that. And then, as far as digital margins, there really isn't such thing as digital margin versus a store margin anymore, because roughly 50% to 60% of all of our digital demand is fulfilled out of that local fulfillment center. Again, why it's so important to have stores that are within 20 minutes of the U.S. consumer, so that's the approach that we've taken, and we're going to continue to lean into that, because it differentiates us from the competition.

Got it. When you think of the brands that you're getting like you mentioned about Gucci, will that be ongoing? Was it one-time in nature? And how does that type of a margin differ relative to your corporate average?

Great question, Dana. And we are working hard, our merchant team to go build relationships with brands to create differentiated products. So, it's not just finding a Gucci. It's also going to those top 10 or 50 brands and saying, 'We know we're selling the same product you carry. But as the largest women's adult branded footwear retailer, you got to give us differentiated product.' And that's part of being in our portfolio and being our partner is you've got to build product that you can only find exclusively within DSW or within Shoe Company as we grow our business. So that's the approach that we're trying to take with all the brands. As it relates to specifically luxury, we're continuing to work with Gucci and other partners like that to bring product to life on our site that will attract a different customer and give our current customer a look into product that they've never seen before. And from a margin standpoint, I'm really proud of the fact that the product that we've brought to life in that space is margining at rates that are comparable to our normal margin. And that's amazing, given that you're selling it in AUR 10 times what we sell a normal shoe for. And I think you get that data. That's remarkable in our space. Q – Dana Telsey: Thank you. A – Roger Rawlins: Thanks, Dana.

And our next question today comes from Tom Nikic with Wells Fargo. Please go ahead. Q – Tom Nikic: Hey, good morning, guys. Thanks for taking my question. A – Roger Rawlins: Good morning, Tom. Q – Tom Nikic: Jared, I wanted to ask about the planned store closures, the 10% to 15% of the fleet. Just a quick clarification, is that U.S. only or does that include Canada? A – Jared Poff: The – it – right now, it's U.S. only, but we are absolutely looking at the same analysis in Canada. The store economics by unit are very different when you're talking about much, much smaller stores with much, much lower rent structures and fixed cost structures, Shoe Company versus DSW. So I don't know that, the same type of results will pop out. But what we talked about right now is just U.S. DSW stores. Q – Tom Nikic: Got it. Okay. Thanks. And is this a situation where you would look to do those closures like with natural lease expirations, or would you kind of sort of rip the band-aid off and be a little bit more aggressive and proactive in making those closures? A – Jared Poff: Yeah. It's all going to be a negotiation on each and everyone. What I would tell you is that the list that we have today is not going to be the list that ultimately makes it through. To give you just a little bit of color, as you know, we worked with all of our landlords on the lease deferrals, had great success there. We're in the middle of our actual lease concessions right now and it really is pretty binary. If we've got leverage because of a lease date, we are getting a pretty nice reduction, not exactly to the same extent of traffic declines, but pretty dead on close in rent on those ones. For the rest of them, even with the ask we're not making a lot of traction until you have that critical date come into your discussion. So – and that's very similar to what we're seeing from some of our other retail peers. So as we look at it; one, we're using future assumptions at a store level that will be different. So some stores will fall off just based on performance and some stores will get added on. And more importantly, as our discussions move into the lease term, the natural dates that are coming up, I am certain there will be much more traction made on the discussions with the landlords that will not require us to close necessarily every single store that's on that list right now. So it's very much a moving target, but it is more going to be along the lease life, which, as you know, for our entire portfolio right now averages four and half years. So I'd kind of use that as a benchmark of what it would take us to work our way through that. Q – Tom Nikic: Understood, very helpful. Thanks very much and happy holidays guys. A – Roger Rawlins: Thanks, Tom. Happy holidays.

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.

Thanks, everybody, for joining us today on the call and wish everybody happy holidays, continue to stay safe and healthy, and we will talk to you soon. Thank you.

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.