Earnings Transcript for DBI - Q4 Fiscal Year 2023

Operator: Good morning everyone, and welcome to the Designer Brands, Inc. Fourth Quarter 2023 Earnings Call. [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, SVP of Finance. Please go ahead.

Dustin Hauenstein: Good morning. Earlier today, the company issued a press release comparing results of operations for the 14-week and 53-week periods ended February 3, 2024 to the 13-week and 52-week periods ended January 28, 2023. Please note that the financial results that we will be referencing during the remainder of today's call exclude certain adjustments recorded under GAAP unless specified otherwise. For a complete reconciliation of GAAP to adjusted earnings, please reference our press release. Additionally, please note that remarks made about future expectations, plans and prospects of the company constitutes 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 for joining us this morning. I'd like to begin by recognizing all of our associates for their continued hard work and dedication to Designer Brands. They effectively executed on our priorities, quickly adapted inventory to shifting sales trends, and worked to manage spending levels amidst a challenging macroeconomic backdrop. While we are pleased with where we ended the year, we fully recognize that we are not operating at our full potential. However, as we enter 2024, we do believe we have the right people and processes in place to move our strategy forward. This provides us with renewed confidence during what will be a transitional year as we begin to see the benefits of new leadership and simultaneously work to right-size our cost base in anticipation of future growth. In fiscal 2023, we saw a 7.3% year-over-year decline in total sales, though we were still able to deliver EPS at the upper end of our guidance range. During the year, we saw industry weakness across the market. According to Circana, dollar sales in the footwear industry contracted year-over-year for both the fiscal third and fourth quarters consecutively; the first time we have seen a quarterly decline since 2020. This impacted us most within our U.S. retail and Canada retail segments as our footwear offerings are highly discretionary. Within our U.S. retail segment, sales declined 9.2% for the full year compared to 2022 as we continued to operate with a seasonal mix approximately 50% above the market. The unseasonable warm weather we witnessed in the back half of the year contributed to softness in our seasonal offerings and as a result, we instituted necessary promotions to ensure that we exited the quarter with healthy levels of inventory. During the fourth quarter, we achieved sales of $754.3 million, a decrease of 0.8% versus the fourth quarter of 2022, with January and the 53rd week specifically providing a boost to our U.S. retail and Canada retail segments as the seasonal category rebounded. While this seasonal rebound was not enough to offset the challenges we experienced in the fall, we did see some bright spots throughout our assortment. Contrary to the reduced demand we experienced in dress and seasonal, customers continued to lean into casual and athletic. Both of these categories saw positive comps during Q4. Notably, kids athletic sales were up 15% compared to the fourth quarter of 2022, in part due to the return of Nike. Our results are less indicative of this exciting strength we're seeing in casual and athletic, given we remain underpenetrated in these growing segments. We acknowledge our overall performance was lacking and we are laser-focused on moving swiftly to evolve our product offerings and reinvigorate our assortment. At this point, we are encouraged by the comp sales performance we're seeing quarter-to-date. We anticipate comps will improve throughout 2024 and expect an inflection in the second half as we lap a weak Q3 2023. That being said, there is a high degree of uncertainty headed into 2024, given the discretionary nature of footwear, the uncertain macro environment, the upcoming 2024 U.S. elections, and ongoing international conflicts. But we are continuing to address the items within our control that are most immediately impactful to our turnaround. Perhaps most importantly, we have brought in talented new leadership

Jared Poff: Thank you, Doug, and good morning everyone. I would like to echo Doug's excitement regarding the addition of Andrea to our team and the strategies that she and Laura are already driving across the organization. Their combined expertise and proven experience in the U.S., along with that of Mary Turner in Canada, are tremendous assets to Designer Brands. Turning to our financial performance. We delivered solid fourth quarter results that contributed to full year 2023 performance at the upper end of our guidance. We saw a sequential improvement in our comps from the third to fourth quarter with the improvement accelerating in the month of January specifically. Despite these improvements, fourth quarter adjusted earnings per share was a loss of $0.44, negatively impacting our full year adjusted earnings per share of $0.68. Let me provide a bit more detail on our fourth quarter and full year financial results. For the fourth quarter of 2023, net sales of $754.3 million were down 0.8% versus the prior year period and were down 7.3% on a 13-week comparable basis. Notably, our 53rd week generated $42.5 million in sales. Full year 2023 net sales of $3.075 billion were down 7.3% versus the prior year period and down 9% on a comparable 52-week basis. We attribute this shortfall to continued macro pressures, a highly promotional retail environment and the impact of warm weather on our seasonal footwear business. In our U.S. retail segment, comps were down 7.4% in the fourth quarter, an improvement compared to down 9.8% in the third quarter of 2023. The negative comps were primarily driven by weaker performance in our seasonal business, slightly offset by stronger sales in our casual, athletic and athleisure offerings. As Doug mentioned, this was all against a backdrop of year-over-year contraction in the overall footwear market for the second consecutive quarter. For the full year, U.S. retail comps were down 9.5%. Our Canada retail segment comps were down 9.2% for the fourth quarter, driven by macro challenges. Notably, this was on top of a strong fourth quarter performance last year. For the full year, Canada comps were down 5.9% following a very strong 2022, which saw comps up nearly 30% as a result of the phasing of Canada's post-COVID recovery. Finally, in our Brands portfolio segment, sales were up 37.7% in the fourth quarter. For full year 2023, sales were up 6.5%. Both were driven primarily by the acquisition of Keds, Topo Athletic and the launch of Le TIGRE. The performance of vincecamuto.com continued to gain momentum with comps up 5.9% in the quarter, lapping an already strong year. Full year performance for vincecamuto.com was also solid with comps up 6% versus the prior year as new wide-calf boot offerings developed traction with our customers. Consolidated gross margin of 27.5% in the fourth quarter decreased 170 basis points versus the prior year, primarily driven by promotions. Full year 2023 consolidated gross margin was 31.7% compared to 32.6% last year, a decrease of 90 basis points. As a reminder, we've expanded our gross margin over 300 basis points since pre-COVID. In the fourth quarter, our adjusted SG&A was 31.8% of sales compared to 27.5% in the prior year period. For the full year 2023, our adjusted SG&A was 29.1% compared to 26.6% in 2022. As previously highlighted, this deleveraging was largely a result of a declining top line coupled with the increases in underlying fixed expenses as a result of several acquisitions we completed in 2023. As Doug noted, we are examining all areas of the organization to identify cost savings, efficiencies and synergies within our infrastructure and administrative support. For the fourth quarter, adjusted operating loss was $30.2 million, which includes $6.6 million in additional operating income generated in the 53rd week compared to a $15.1 million gain in the prior year. For the full year 2023, adjusted operating profit was $89.6 million compared with $207.5 million last year. In the fourth quarter of 2023, we had $9.9 million of net interest expense compared to $4.3 million last year. For the full year 2023, our interest expense was $32.2 million compared with $14.9 million in the prior year. Our higher interest is a direct result of the term loan we installed during the year as well as higher average borrowings on our ABL at higher interest rates. Our effective tax rate for the fourth quarter on our adjusted results was 37% compared to 56.7% last year. For the year, our effective tax rate was 24.8%, which was below last year's 30.6%. Our fourth quarter adjusted net loss was $25.3 million or negative $0.44 in diluted earnings per share. Weaker performance along with higher interest expense culminated in a lower diluted EPS compared to the $0.07 per share in fourth quarter of 2022. Finally, our full year adjusted net income was $43.2 million or $0.68 per diluted share compared to $133.7 million or $1.85 earnings per share in 2022. Turning to inventory. We ended the fourth quarter with inventories down 5.7% versus the prior year, as we continue to emphasize a clean inventory position, and prioritize placement, of our newest product. Brand portfolio inventory ended the fourth quarter down 8%, and adjusted for the acquisition of Topo and Keds, inventory would have been down 23%, to last year. We feel good about our inventory levels heading into the new fiscal year, and our strong balance sheet, provides us flexibility to continue, to chase and take action on opportunistic buys. As I highlighted on our third quarter earnings call, we strategically deployed significant promotions during the Black Friday and Cyber Monday period, to clear through seasonal product, and right size our inventory positions, to prepare for a revitalized selection heading into the spring season. As we continue to shift our assortment mix, to include more of the brands we know our customers desire, we anticipate we will drive higher sell-throughs and faster inventory turns, ultimately giving customers newness, each time they shop at DSW. In fiscal 2023, I'm pleased to report that Designer Brands returned $114.3 million to shareholders, through a combination of dividends and share repurchases. During the year, we repurchased an aggregate 9.7 million Class A common shares, at an aggregate cost of $102.2 million and paid $12.2 million in dividends. As of February 3, 2024, $87.7 million remained available, under our share repurchase program, which as a reminder has no set expiration date. We have also once again, reaffirmed our commitment to returning cash to shareholders, declaring a $0.05 per share dividend for the first quarter of 2024. I'm proud that Designer Brands, was able to generate strong cash flows, and shore up our balance sheet during 2023, despite the sales headwinds. For the full year, we generated $107.4 million of free cash flow, defined as cash provided by operating activities less cash paid for property and equipment, reflecting a strong cash conversion rate, and the resiliency of our business, amidst macro headwinds. We ended the fourth quarter of 2023 with $49.2 million of cash and our total liquidity, which includes cash and availability under our revolver was $210.1 million. As a reminder, we continue to await the receipt of the remaining $40 million of our CARES Act tax refund, due to us from the IRS. This refund has cleared all audits, and is simply awaiting funding, by the U.S. Treasury. On January 29, 2024, we borrowed the remaining $60 million available, under our new term loan. We remain well inside of all covenants, and have strong relationships, with all of our credit providers. Total debt outstanding was $434.2 million as of the end of the fourth quarter. Before discussing our 2024 outlook, I would like to provide an update on changes we are implementing, within our brands portfolio segment, to move towards a consistent approach, to selling of our own brands, to our other segments. As it stands today, certain own brands and our segment sales are recorded as wholesale sales, with a corresponding gross profit identical to sales made to external wholesale customers. At the same time, certain other own brands are recorded as commission income based on the product being designed, by our brands portfolio segment at a commission rate, but the product is direct ordered by our retail segments from the factories. Starting in the first quarter of fiscal 2024, we plan to transition inter-segment commission income transactions, to a standardized and streamlined approach and transact as wholesale sales, with an attributable gross margin. As a result, reported sales as well as gross profit, will increase for our Brand Portfolio segment, while the U.S. Retail segment will have lower gross margin upon selling through to the end customer as its inventory cost basis will be higher. On a total DBI basis, there is no change, due to consolidation through intercompany eliminations. While this does not change our ultimate consolidated financial results, it will provide our teams, with greater clarity and consistency in the business planning, and execution process at the brand level. For full year 2024, we are anticipating this will add approximately $70 million of sales and $20 million of gross profit, to the Brand Portfolio segments reported operations. This will also increase, the amount of sales and gross profit that is eliminated in consolidation as captured separately, from the reported segments results. Before I conclude, I want to share a few thoughts on our 2024 guidance. We expect net sales growth in the low single-digits versus last year, even when considering the headwind of the sales recorded in the 53rd week of 2023. We also expect comparable sales, to be up low single-digits, improving sequentially as the year progresses. The accelerating comp growth, is expected to be driven, by our new assortment strategy increasingly coming to life in our stores, as well as an assumed continuance of improved DSW awareness, as a result of optimized marketing. And while our comparable sales growth, is expected to improve sequentially throughout the year, the 53rd week last year adds a bit of calendarization volatility to our quarterly year-over-year sales growth, with key selling weeks sometimes falling in non-comparable quarters, and of course the loss of an entire selling week in Q4. This results in Q3, being projected as our strongest growth quarter and Q4, to be our weakest. We anticipate sales in our Brand Portfolio segment, will increase mid-single digits driven by double-digit DTC growth, and key wholesale growth, especially at Topo and Hush Puppies, excluding the impact of the change in selling approach, I just discussed. Turning to factors impacting our profitability, while we are not providing detailed P&L line guidance, directionally, I want to help build a bridge from our top line sales, to net income. First, we are anticipating our gross profit rate to be relatively flat to slightly up to last year, as fewer promotional markdowns help to mitigate, some of the lower merchandise margin associated, with increasing penetration of key national athletic brands within our DSW assortment. We also expect to see slight expense leverage in our SG&A ratio, as we are aggressively pursuing, identifying, and unlocking efficiencies, across the organization, while reinvesting in key areas such as marketing, personnel, and technology. We anticipate an effective tax rate of roughly 30% for fiscal 2024, and expect earnings per share, to be in the range of $0.70 to $0.80, representing a roughly 10% increase at the midpoint, when compared to our 2023 results. For the reasons mentioned previously, including sequential top line improvement as a result of our retail assortment changes, as well as the deployment of some of the expense initiatives not starting to materialize until Q2, we anticipate our EPS growth over last year, to be negative in the first half of the year, with healthy year-over-year growth in the second half. We expect capital expenditures, to be in the range of $65 million to $75 million for the year. In conclusion, we are confident we are making the appropriate changes, to move our organization in the right direction, and could not be more assured in the new leadership, we have at the helm. We have an important transition year ahead, as we plan to return to growth, on the top and bottom lines, while continuing to generate strong free cash flow, and our teams will continue to be laser focused on reducing excess spending, while reinvesting to accelerate our brand, and retail strategies. With that, we will open the call for questions. Operator?

Operator: [Operator Instructions] And our first question today comes from Mauricio Serna from UBS. Please go ahead with your question.

Mauricio Serna: Great. Good morning and thanks for taking my questions. First, I wanted to maybe you could talk a little bit more, about what you're seeing on a quarter-to-date. You mentioned you were pleased, with the comp sales performance so far, but maybe you - could give us a little bit of insight. How does that compare to the comp sales that you had in Q4? And then, maybe you - could provide a little bit more, details on the guidance for the interest expenses. How should we think about interest expenses for 2024? Thank you.

Doug Howe: Hi, Mauricio. This is Doug. I'll start and then I'll turn it over to Jared. Yes, we are pleased, as we said, with the results that we're seeing season to-date. It's largely driven, by strength that we're seeing in the casual area, as well as athletic and in kids. And it's, again, a significant improvement to what we saw coming out of Q4. So early days, so a lot of volatility, obviously, in the market. But we're very pleased with how the quarter is starting to play out.

Jared Poff: And Mauricio, this is Jared. On the interest, given that we will have the full amount of the term loan, over the entire balance of the year, but then offsetting a little bit with earned cash flow paying down the ABL, we are anticipating relatively the same interest, yearly interest expense, maybe just a couple of million dollars, more than last year in totality.

Mauricio Serna: Got it. Very helpful. And then maybe, if I'm thinking about the operating margin, it seems that gross profit could be like, sorry, gross margin could be flat. But you're mentioning maybe some slight expense leverage. So, if I put those things together, I think like you're expecting, like a modest expansion, on a year-over-year basis. Just wanted to make sure, I understand that right. And lastly, if you could just remind us, or talk a little bit more about, how the Nike business has been going. You said like it's near its pre-COVID level penetration. Maybe like, could you remind us how much that used to be and any additional detail would be very helpful? Thank you.

Jared Poff: Yes, I will start with answering your first question, and that is, yes, a modest expansion on the up-income rate line. And then I'll turn it over to Doug for Nike.

Doug Howe: Yes, on Nike, as we said in the remarks, the brand went to one of our top national brands pretty quickly in the quarter. We're very pleased with the results. They continue to be great partners. It's nearing the penetration that it was pre-pandemic. So again, we feel really good about that. Continuing to get access to product that we've never had before. Again, they've been great partners. Very pleased with the progress that we're seeing there, as well as overall active. And Nike, that's kind of a positive halo effect, on some of the other businesses as well. Really strong driver of the kids' business. We're seeing nice trip drivers coming out of driven by Nike kids that are actually positively impacting, the women's business as well. So again, couldn't be more pleased with the partnership today.

Mauricio Serna: Got it. Very helpful. Thank you.

Operator: Our next question comes from Dylan Carden from William Blair. Please go ahead with your question.

Dylan Carden: Thanks a lot. Just trying to kind of simplify this a little bit. For the kind of sales guide on the year, I know you're not going to guide component pieces of it. But as you start lapping maybe a full branded portfolio, provided you don't make any other acquisitions. Is the idea here that DSW banner, is going to be doing more of the heavy lifting, until that portfolio kind of finds footing? Or just - given the beat kind of on sales, or sort of the expectation on sales this quarter, versus the comp, just trying to kind of set expectations appropriately for the year, if that makes sense?

Doug Howe: Yes, yes, Dylan. Certainly just given the sheer size of DSW vis-a-vis the Brand segment, the sales growth and comp growth we guided to would indicate, you've got more just actual dollar volume coming from that segment. However, we did guide that the Brand segment will actually grow mid-single digits. And we do have a full year worth. I mean, we acquired both Keds and Topo, at the beginning of last year. So, with all of that put into the mixer, we are seeing mid-single digit growth on the brand side or single-digit growth in our comp, for retail businesses.

Dylan Carden: Sorry, I missed that. But the mid-single digit brand side, that's more, or less given time into acquisitions, closer than that to organic growth, I guess?

Doug Howe: I'm sorry, you broke up there. What was the question?

Dylan Carden: One, I just apologize for missing that commentary. But the mid-single digit growth on the branded side, given the timing of acquisitions, is closer than that to organic growth, sounds like?

Doug Howe: Correct, yes. Yes, that's organic growth.

Dylan Carden: Got it. And is there anything, I guess, when should you start seeing potentially, I guess, kind of to reset, or to level set some of the merchandising architecture within the DSW banner, the idea of pulling out these ancillary brands and kind of adding your own brand of portfolio, some of the shift has maybe shifted to, these other purchase brands. Just - how does the assortment look next year at the DSW level, as far as sort of own brand mix, and how that kind of, helps the overall banner?

Doug Howe: Yes, Dylan, this is Doug. Laura has already made, meaningful progress with the team, obviously just, as her focus is continuing to revitalize the assortment. Most notably, that's really leaning into the areas where we're seeing consumer demand growing and we're underpenetrated, specifically athletic. So that's where we're seeing some really nice growth there. Seeing a really nice growth in the kids' area as well. And a lot of that is on the back of the return of Nike, obviously. But we're maintaining our commitment in own brands. The penetration was essentially flat. That'll evolve, obviously, and the portfolio has evolved, with the acquisition of Keds, Topo, talk about Hush Puppies as well. So again, we'll continue to evolve, but feeling really good about the green shoots, we're seeing already, with the changes that the team has made in this format.

Dylan Carden: Thanks for that. And then final one from me, whether, presumably, it can continue to be volatile, any kind of incremental ways you can mitigate that, either between kind of being leaner on inventory, or athletic penetration?

Doug Howe: This is Doug. I mean, we're going to continue to focus on what we can control. So, the team has done a really good job of managing inventory. We have opened a buy, to take advantage of opportunistic buys, to chase categories and products that are working as well. That's one of our key strengths, honestly, and we're certainly not walking away from that. So, I'd say that's the biggest thing that - we could do. And so, we just stay really close to what's happening, obviously, as we progress through 2024.

Dylan Carden: Great. Thanks a lot, guys.

Doug Howe: Yes. Thank you.

Operator: [Operator Instructions] Our next question comes from Dana Telsey from Telsey Group. Please go ahead with your question.

Dana Telsey: Hi, good morning, everyone. As you think about just the health and the state of the consumer, whether it's in the U.S., or whether it is in Canada, what are you seeing that are the same, or the differences, and how has it changed exiting '23 and into 2024 so far, whether online, or in-store? And speaking about stores, how are you thinking about your store base in 2024, whether it's openings, or closings? And lastly, very good, very nice hire and welcoming, Andrea, to the fold. As you think about the assortment and category assortment and margin profile, what looks different a year from now than what it is today in attracting customers and gaining market share? Thank you.

Doug Howe: Great. Thanks, Dana. This is Doug. As it relates to your first question on the consumer health, as we said, we are encouraged by the trend change that we've seen, obviously, in Q1, as it compares to Q4. Overarching, I would say, the customer is definitely responding to newness. And that has been a dedicated focus, obviously, driven by Laura in the U.S. and then Mary Turner in Canada. So the team has been maniacally focused on that, leaning into categories that were underpenetrated, and where we're seeing really nice demand, specifically athletic. The casual businesses, had a nice buoyancy as well. And then the kids' businesses is coming on strong as well. We talked about the positive impact of Nike, but it's definitely broader than that. So, I'd say overall, it's really around we're seeing a trajectory change from what we saw coming out of Q4. Still early on, obviously, and still volatility. As we think about channel growth, we really think agnostically about that, between stores and digital. The digital business has been stronger, from a comp perspective than stores. But again, we're big believers in stores. We are definitely seeing an increase, modestly in traffic there. We're continuing to invest in top of funnel marketing, which had a really positive holdout result, to increase the traffic there. So, we're feeling good about that. We're leveraging stores in a different way. And we think it's very much this ecosystem. 60% of our digital demand, is fulfilled by our stores. 90% of our e-commerce returns, are made in stores. So there's a lot of footsteps in the confluence, of those two channels. So, we really think about those holistically. We talked about the eight net new stores in Canada. So, we're excited about that. And we don't have any plans to make any material differences in DSW. Again, it really goes back to the work that I mentioned that Laura's focusing on. How do we update those stores in a very thoughtful way, with LED lighting, paint, hardwood flooring, and think about making the experience, even more inviting and enjoyable? So lots of focus on that, but no major change in the store count. And then as it relates to your last question, it's early days with Andrea. But I've been really pleased, with the progress that she's making, already with the team. She's maniacally focused on profitability, as well as prioritizing the brands that, we see significant upside growth. There's been some meaningful changes, through investments in the brand portfolio in the last 12 to 15 months, obviously, with the Keds acquisition, Topo, Hush Puppies, and Le TIGRE. So again, there's a lot of net new in the portfolio that, she has arsenal to work with. But very, very early days. We'll come back, with more specifics, as she's had a little bit more time in the role. Thanks for your question.

Dana Telsey: Thank you.

Operator: And ladies and gentlemen, with showing no additional questions, we'll conclude the question-and-answer session. I'd like to turn the floor back over to Doug, for any closing remarks.

Doug Howe: Thank you all again, for joining us this morning. We look forward to continuing, to update you on our progress, as we progress through 2024. Thanks again.

Operator: And ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your lines.