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…

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…

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…

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.