Earnings Transcript for DBI - Q3 Fiscal Year 2024

Operator: Good morning and welcome to the Designer Brands Third Quarter 2024 Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note, today's event is being recorded. At this time, I'd like to turn the floor over to Dustin Hauenstein, Senior Vice President of Finance. Please go ahead.

Dustin Hauenstein: Good morning. Earlier today, the company issued a press release comparing results of operations for the 13-week period ended November 2, 2024, to the 13-week period ended October 28, 2023. Please note, that the financial results that we will be referencing 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. Additionally, please note that remarks made about future expectations, plans and prospects of the company constitute forward-looking statements. Results may differ materially due to the various factors listed in today's press release and the company's public filings with the SEC. The company assumes no obligation to update any forward-looking statements. Joining us today are Doug Howe, Chief Executive Officer; and Jared Poff, Chief Financial Officer. Now, let me turn the call over to Doug.

Doug Howe: Thank you everyone for joining us this morning. We were pleased with our strong start to the third quarter, anchored on the success of back-to-school season which was fueled by our athletic and athleisure offerings and led to positive comps in August. This gave us confidence that we had reached the inflection point in our business that we have been working towards. However, we saw a tough transition into the fall seasonal business as a result of unseasonably warm weather. This was exacerbated by an ongoing pullback in consumer discretionary spending due to sustained uncertainty in the macro environment. While we saw demand below expectations across most of our categories, our boot business, while already planned down approximately 15%, was down 27%. However, according to Circana, for Q3, footwear sales, excluding boots remained flat to prior year in the footwear market, while DSW footwear sales, excluding boots, grew 8% versus prior year, outpacing the footwear market results. This was largely due to our athletic category continuing to comp positive throughout the quarter. Additionally, in U.S. Retail, we saw growth across key categories in the quarter like women's dress, luxury, athletics and kids and our top 8 brands, 7 of which were athleisure, continue to lead the way. As we navigate through the remainder of the year, we are mindful that pressures are likely to continue. As such, we will continue to focus on those initiatives within our control and lean into areas where we are winning and the customer is shopping. I will get into the strategy in a moment but I want to extend a sincere thank you to our employees for their diligence and commitment in applying our refreshed strategy. Let me first touch on our consolidated results. In the third quarter, our sales were down 1.2% compared to last year and our comps were down 3.1% at a consolidated level. This was primarily driven by a negative 2.8% comp in our U.S. Retail segment, driven by the dynamics I discussed earlier. Despite these external pressures, we continue to see our strategic priorities yielding strong results. According to Circana, for Q3, DSW footwear sales were in line with the footwear market versus last year, outpacing the market in performance and leisure footwear as well as in dress occasion footwear. This helped to offset negative boot performance at DSW. Importantly, our adjusted operating income improved roughly 40% compared to last year, taking us to $43.6 million. Our profitability also improved sequentially as a result of ongoing expense optimization and the reversal of incentive compensation recognized in previous quarters following softer-than-expected performance. Turning to our retail business. U.S. Retail sales were down 2.6% compared to last year. Comp sales were down 2.8% in the quarter, driven by continued growth in athletic and athleisure which was more than offset by weaknesses in seasonal. We aren't the only ones who felt this weakness. According to Circana, both DSW and the footwear market were down double digits in boot sales for Q3. As we continue to evolve our assortment, seasonal still remains an area where we are significantly penetrated, therefore, overly affecting our consolidated results. We noted to you last quarter that we had taken unprecedented material actions to reduce our seasonal assortment into the fall. As a result of the continued weakness we've seen, we have proactively pulled back even further on fourth quarter receipts in seasonal as part of our efforts to ensure we are moving forward with a healthy inventory position by the end of the year. Our target for the end of Q4 is to have inventory flat to up low single digits compared to last year. It is clear more decisive actions are needed to decrease seasonal penetration on an ongoing basis and as such, we are planning accordingly for 2025. We are committed to more aggressively leveraging consumer insights to lean into our greatest areas of differentiation. This includes prioritizing investments and focusing on areas where we know we differentiate ourselves, including our stores. As we continue to focus on executing on those things within our control, I'm going to briefly walk through our efforts against DSW's 3 strategic pillars in the third quarter

Jared Poff: Thank you, Doug and good morning everyone. We continue to be pleased with the results of our investment areas that we believe will support our outperformance versus the market in those areas, even while challenges persist. Let me provide a bit more detail on our financial results from the third quarter, followed by an update to our annual guidance. For the third quarter of fiscal 2024, net sales of $777 million were down 1.2% versus the prior year period as reported and were down 3.1% on a 13-week comparable basis. In our U.S. Retail segment, comps were down 2.8% in the third quarter. As mentioned, our performance was bolstered by our back-to-school season which saw double-digit comps in athletic and kids. Unfortunately, this strong performance was more than offset by negative comps in seasonal categories. Our Canada Retail segment comps were down 4.6% in the third quarter, driven by unseasonably warm weather during what is usually a heavy boot sales season as well as continued macro challenges that have led to a reduction in overall consumer discretionary spending activity. Total sales were up double digits as a result of the addition of Rubino locations to our store base. Finally, in our Brand Portfolio segment, sales were up 18.5% in the third quarter. As a reminder, starting this fiscal year, we have harmonized our approach to how we transact business between our Brand Portfolio segment and our Retail segments. This change resulted in approximately $15 million of year-over-year additional sales for our Brands segment in the quarter that gets eliminated in consolidation. We saw notable strength in our DTC sites where we have been investing. In particular, topo.com delivered a triple-digit comp. The strength of Topo, however, was offset by a reduction at vc.com, leading to a total comp decline of 7.5% for our brand DTC sites. Consolidated gross margin of 31.8% in the third quarter decreased 80 basis points versus the prior year, primarily driven by lower IMU as a result of our continued penetration shifts into national brands and specifically more athletic and athleisure footwear. Our adjusted SG&A was 26.7% of sales, a 220 basis point improvement from the third quarter of last year. This was driven by expense cuts made in response to the challenged top line, including the reversal of management incentive compensation accrual in the quarter which was slightly offset by expense deleverage as a result of top line decline in sales. As noted last quarter, we are undertaking an expense efficiency initiative with outside consultants. Our partners have identified a number of opportunities to spend more effectively and we now have a detailed expense savings road map that we will begin executing in 2025 and we look forward to sharing more with you in the coming quarters. For the third quarter, adjusted operating income was $43.6 million, an improvement over $31.4 million last year and the first quarterly year-over-year improvement in the last 2 years. In the third quarter of 2024, we had $11.6 million of net interest expense compared to $8.8 million last year. Higher interest expense is a direct result of the term loan we installed last year as well as higher interest rates on our ABL. We drew on our ABL in the third quarter as our team and the Board deemed it prudent to continue our share repurchase activity as evidence of our conviction in our long-term strategy. To that end, we repurchased $50.6 million worth of DBI shares at an average price of $6.59 in Q3, our biggest share repurchase of the year. Our effective tax rate in the third quarter on an adjusted results was 54.8% compared to 34.6% last year. Our third quarter adjusted net income was $14.5 million versus $14.8 million last year or $0.27 in diluted earnings per share versus $0.24 last year. Turning to our inventory; we ended the third quarter with inventories up 6% versus the prior year, mostly driven by the significant lack of demand for seasonal footwear. As a result, Doug noted that we have pulled back further on fourth quarter receipts for seasonal product to ensure we are moving into a healthy inventory position by the end of the year. We ended the third quarter with $36.2 million of cash and our total liquidity which includes cash and availability under our ABL revolver was $154.5 million. Total debt outstanding was $536.3 million as of the end of the third quarter. Before I conclude, I want to take a minute to discuss our fiscal 2024 guidance. Through the first half of the year, we had been signaling our confidence in an inflection point in the third quarter, a sentiment bolstered by the positive comps we saw in August as a result of our successful back-to-school efforts. However, the unseasonably warm weather in the September and October period, coupled with sustained consumer pressure, significantly dampened performance in the last 2 months of the quarter. As we look ahead, we feel it is prudent to give you an update on our expectations for the full 2024 results. As a reminder, our guidance includes the headwind of the sales recorded in the 53rd week of fiscal 2023 as well as the lapping of Nike's return to our assortment in the fourth quarter of 2023. Importantly, we do still continue to project our fourth quarter as our strongest comp growth quarter. Should macro conditions remain consistent to what we are seeing now, we would anticipate net sales growth for the year to be down low single digits which incorporates the impact of the loss of the 53rd week compared to prior guidance of flat to up slightly. We would expect external wholesale sales in our Brand Portfolio to be down low single digits versus prior guidance of flattish. Additionally, despite depressed sales levels, we have been generating larger profits and the midpoint of our guidance, excluding the impact of the 53rd week, would contemplate the second consecutive quarter of year-over-year adjusted operating income growth, leading to an annual diluted earnings per share outlook in the range of $0.10 to $0.30 versus our prior guidance of $0.50 to $0.60. Our weighted average diluted shares outstanding are anticipated to be approximately 53.5 million for the third quarter and approximately 55.4 million for the full year, given the share repurchase activity that has occurred thus far throughout the year. At this time, we would like to reaffirm our expectations for capital expenditures to be in the range of $60 million to $65 million for the year. Our estimates also assume an effective tax rate of roughly 32%. I remain confident that our outlined initiatives will continue to deliver improved performance over time. Remaining focused on our core business strategy throughout the holidays will position us for stronger performance over the long term as these external challenges ease. With that, we will open the call for questions. Operator?

Operator: [Operator Instructions] Our first question today comes from Dylan Carden from William Blair.

Dylan Carden: Jared, sorry if you mentioned this, November trends are just trends generally once the weather kind of cooperated. Did you provide that?

Jared Poff: Yes. What we said is what we're -- what the midpoint of our guidance implies. And to be perfectly honest, I would say it's indicated or informed by the November trends we're seeing. And on kind of through the holiday, what we saw was overall demand slightly below last year but it was distorted. Stores were actually positive digital because we were not chasing excess boot inventory like we were last year. So very different targeted promotions was below last year but gross margin dollars and rate, obviously, were well above last year. And we're seeing that trend continue. So our midpoint of the guidance kind of incorporates all of that.

Dylan Carden: Great. And then kind of related to that, are you losing share in boots? I mean, the industry was also down double digits. You were down, I think you said 27% and do you care? And I guess sort of the implied question in that is, is this sort of a water bed effect at this point where you're kind of seeing gains elsewhere but losses in other places and kind of keeping you at a net disadvantaged position until you get the assortment and a better sort of mix?

Doug Howe: Yes. This is Doug. Dylan, thanks for your question. We consciously planned the category down, as we mentioned, 15%. It was almost double that decrease. I mean, we're going to be very strategic about continuing to kind of de-weatherize the business, obviously. So we're still working through the level of what that would look like. Fourth quarter is actually even a higher percent of our business in the boot category, obviously, than Q3. And we have seen a bit of a rebound with the weather as we move through the quarter. And then as Jared said, we've been particularly pleased with how we've seen that show up in our stores. I think the assortment work that the teams are doing, I would give credit to that as well as the marketing and messaging. We really showed up for holiday with messaging in our stores. So that's been favorable as well. But again, we're going to continue to be conservative on the seasonal categories as we've stated.

Dylan Carden: And then to that point, you're not leaving money on the table here by sort of overcorrecting for boots as the weather has turned, I guess, would be one thought.

Doug Howe: No, we don't believe so at all. I mean, we still saw a slight decrease in traffic, right? So that's why we're excited about the marketing that we'll be leaning into in a more aggressive way for next year with regards to just driving that traffic but not leaving business on the table at all.

Operator: [Operator Instructions] Our next question comes from Mauricio Serna from UBS.

Mauricio Serna: Great. Just wanted to hear because -- sorry if I missed this. Did you talk about what was your performance in -- across your top 8 national brands? What are you seeing there? And also if you mentioned what was your quarter-to-date trend? And also -- and on the other hand, on the balance sheet, saw -- in cash flow, you saw like you mentioned you did your biggest share repurchase of the year. How are you thinking about debt levels management considering that, I guess, like the business has been a little bit more challenged than expected?

Doug Howe: Mauricio, this is Doug. Thanks for your question. I'll take the first 2 on the brand performance and then quarter-to-date and then I'll turn it over to Jared for the debt. Yes, we did share the performance of the top 8 brands. They were up 27% in Q3. It was roughly about 40% of the total. Really proud of the work the team has done on really going after the relationships with those top brands, being mindful also that we're not becoming overly reliant on any of them. If you think about 40% penetration on 8 brands, none of them are close to 10% of the business. So we think that's a very thoughtful approach. Quarter-to-date, as Jared said a couple of moments ago, is in line with the guidance that we're providing. Again, we saw a little bit of softness in Black Friday and Cyber Monday but we're seeing an expansion in margin dollars and that's continuing as we move through December as well, largely due to the fact that we're not as promotional as we were last year because we're in a much better position on inventory.

Jared Poff: And on kind of debt level management, what we always look at is more of a liquidity management. We've got 2 big working capital cycles a year. We're actually on the cash generation side of one of those cycles happening right now, very, very typical and cyclical. We are comfortable with our overall debt levels and more importantly, comfortable with our liquidity levels. I would say, obviously, we want to remain cautious as we just look at the consumer environment out in the future. So we feel like we've got our capital structure in the right place right now but always have an eye on that and certainly also an eye on to the interest load that it brings.

Mauricio Serna: Got it. Very helpful. And then just could you provide any details on what you've seen with Nike? I remember like you were very excited about new -- just having more product available from that brand this year than even when you had the brand a few years before?

Doug Howe: Yes, this is Doug. I mean, we continue to be very pleased with the Nike performance. They couldn't be better partners. Really encouraged. I mean, still a net new positive for us. We have now lapped when they came back to DSW specifically. But again, couldn't be more pleased with the business and the relationship. They've been great partners.

Operator: And ladies and gentlemen, at this time, in showing no additional questions, I'd like to turn the floor back over to Doug Howe for closing remarks.

Doug Howe: I'd like to thank everyone for joining us today and we look forward to updating you as we continue to make progress on our strategic priorities going forward. Thanks again for joining us.

Operator: Ladies and gentlemen, that does conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your lines.