Designer Brands Inc (DBI) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the third quarter 2010 DSW Incorporated earnings conference call.

My name is Noellia, and I'll be your coordinator for today.

At this time all participants are in a listen-only mode.

We will be facilitating a question-and-answer session towards the end of this conference.

(Operator Instructions) As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Leslie Neville, Director of Investor Relations.

Please proceed.

Thank you and good morning.

Welcome to DSW's third quarter 2010 earnings conference call.

With me today in Columbus are Mike MacDonald, our CEO; Debbie Ferree, our Vice Chairperson and Chief Merchandising Officer; and Doug Probst, our CFO.

Before we proceed please note that earlier this morning we issued a press release detailing the results of operations for the quarter-ended October 30, 2010.

Various remarks we make about the future expectations, plans and prospects of the Company constitute forward-looking statements.

The actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those listed in today's press release and in our public filings with the SEC.

So with that I will turn it over to Doug.

Thanks, Leslie.

Good morning, everyone.

I will cover the financial performance for the third quarter and discuss our current outlook for the remainder of 2010.

At that point I will turn it over to Mike to give you an update on our strategic initiatives.

As previously reported, net sales for the third quarter increased to $489.3 million.

Same-store sales increased 10.1% for the comparable period on top of an 8.7% increase a year ago.

By segment our comps for our DSW business which includes DSW.com were up 10.6% and comps for our lease business were up 4%.

The merchandise margin rate for the third quarter was 45.1% but as expected since the beginning of the year, the rate for the quarter declined from last years historically high rate of 46.3%.

Please make no mistake, we were very pleased with our margin rate and margin dollar performance in the third quarter.

The occupancy expense dollars were virtually flat and as a result the rate decreased 100 basis points mainly due to the large positive comp in the quarter.

As a percent of sales our fulfillment and distribution center expense increased due to the incremental contribution of our DSW.com business and to support our growing size replenishment efforts.

The net result was a third quarter gross profit rate of 32.5% which brings our year-to-date rate to 31.9%.

Although the fourth quarter will not be as high, we expect to achieve an annual gross profit rate of greater than 30% for 2010.

The SG&A rate decreased 180 basis points to 21.2% in the quarter due to the increased sales and overall decrease in overhead expense and a reduction in bonus expense compared to the prior year.

You may recall that our business began to accelerate in the third quarter last year requiring us to increase the accrual for our annual incentive compensation.

Operating income for the third quarter was $55.1 million or 11.3% of sales.

These were both new quarterly highs for DSW and compares favorably to the $44.7 million generated a year ago.

Additionally, we recorded non-operating income of $1.5 million related to the sale of a fully impaired auction rate security.

Net income for the quarter increased to $35.5 million compared with $26.6 million last year, equating to an increase in diluted earnings per share to $0.79 versus $0.60 a year ago.

Regarding our balance sheet, you will recall that at this time last year, inventory was down 11% on a cost per square foot basis.

This year we ended the third quarter with inventory up approximately 13% meaning our two-year inventory level was up 2%.

Overall we are pleased with our inventory levels and merchandise mix as we enter the fourth quarter and begin our transition into the Spring season.

Capital expenditures in the quarter were approximately $17 million and are estimated to be approximately $50 million for the year primarily for new stores, remodels and investments in IT.

And finally, we ended the quarter with cash and short-term investments of $310 million and no debt.

Now, for the outlook for the balance of 2010.

As we began the third quarter, we were coming off a spring season with our comps on a two-year basis at plus 10%.

In the third quarter the two-year comps increased nearly 19% and so far in November, the two-year comps have continued to accelerate even higher.

As a result, today we are again updating our annual guidance for 2010.

We now expect comps for the year to be approximately 12% and estimated annual diluted earnings per share of approximately $2.30 to $2.40.

With that I'll turn it over to Mike.

Thanks, Doug, and good morning, everyone.

Let me add some details regarding third quarter performance.

And then I'll update you on some of our key strategic initiatives.

As you know, we entered the third quarter with some uneasiness about our ability to generate sales growth on top of our very strong sales growth of a year ago.

As it turned out our third quarter comps of plus 10% on a one-year basis and plus 19% on a two-year basis were among the highest in the industry.

We're obviously pleased with these results.

We believe this exceptional performance against very tough comparisons from last year reflects three things.

First, we believe the recognition of the DSW brand is growing quite rapidly, such that more and more Americans know who DSW is.

Second, our unique retail concept is increasingly relevant to a growing percentage of time-pressed and value-conscious customers.

And third, we believe we executed quite well in the quarter.

I'll expand on each of these three factors.

In terms of the increased recognition factor, we have a number of elements that lead us to believe we are touching more and more customers and potential customers.

We've continued our elevated marketing efforts in the areas of broadcast, e-mail, direct mail, social media, and other forms of customer contact.

In addition, we continue to grow our DSW Rewards database.

So far this year we've opened up 4 million new Rewards accounts and DSW Rewards members in total have accounted for 87% of our sales.

Finally, our traffic in both stores and on DSW.com continues to grow quite substantially.

In the third quarter alone, store traffic was up 6% and traffic to the DSW.com site increased 22%.

I also mentioned that our model is becoming more relevant to a growing portion of our potential customers.

Aside from our sales results, my evidence here is a little thin but I really do believe if you're interested in shopping for shoes across a broad spectrum of brands, end uses, fashion styling, and price points, we offer the most compelling selection.

And if you want to make sure you get a good deal every time you shop regardless of the time of day or the day of the week, DSW guarantees you that value.

And if you want to control your own shopping experience, whereby assistance is available yet not required, DSW provides that too.

It's the combination of our assortment and value and shopping convenience that makes our formula so compelling to an increasing number of shoe lovers.

I also mentioned that I thought our good Q3 results reflected strong execution by the DSW team, and here I do have some supporting statistics.

In contrast to last year where we were scrambling to get inventory to feed the sales trend, this year we planned the receipts that would allow us to feed a strong sales trend.

As Doug said our inventory per square foot is up 13% to last year and we're pleased with that stock position.

We also continued our key item emphasis that allowed us to maximize selling in items we placed big bets on.

We also continued to put more of our ongoing product on to our size replenishment system.

We now have about 20% of our stock on this system and we know it is delivering incremental sales.

Our new merchandise planning platform allowed our planning and allocation staff to stay on top of selling trends by class or subclass and by store so they can adjust merchandise receipts accordingly.

At store level, we redoubled our efforts to process freight more rapidly, keep the stores more orderly, and to engage the customers more effectively.

All of these points of execution caused our customer conversion rates to increase by 4% in the stores.

We focused on our conversion stats because that's where the rubber meets the road.

It's a great barometer of how well we're meeting the customers needs.

Now let me give you a few more details on our statistical performance in Q3.

The business was quite balanced across all major categories in the quarter.

Comps by category were plus 10 in Women's, plus 6 in Men's, plus 9 in Athletic and plus 19 in the Accessories/Handbag complex.

This Fall DSW was once again the Boot headquarters for women.

Women's Boots posted a plus 10 comp on top of a comp of plus 47 in the third quarter of last year.

We like to dominate certain categories of merchandise and Boots is one of those categories.

Last year we established ourselves as the place to shop for boots.

And this year, we're building on and strengthening that reputation.

We're pleased with the progress we've seen in Men's.

The Men's business is healthy across-the-board in all categories including both core and fashion styles.

In the Athletic category, the Nike assortment as you will recall was expanded to include Men's Running beginning in Q3.

The addition of this product represents a substantial opportunity for the Athletic category not only in terms of sales but also in terms of building credibility in our Performance Athletic offering.

We've always been known for Fashion Athletic, over time we want to strengthen our reputation in the Performance Athletic category.

Accessories has been another terrific category this Fall.

We really went after the Casual Hosiery category which includes trouser socks, boot socks, tights, leggings, jeggings, and leg warmers.

If you've been in our stores this Fall, you've seen the dramatic improvements we've made in our stock position, our fixturing and our visual presentation in support of the Casual Hosiery category.

It paid off in the third quarter when Hosiery posted a 38% comp increase.

Handbags posted a 12% comp in the third quarter due to the introduction of higher-end brands and greatly improved assortments in our Private Brand bags.

We're also excited about Scarves and Wraps in both fashion and cold weather styles that performed well in Q3 and we believe that performance should continue into the fourth quarter.

As previously mentioned our DSW Rewards Program grew further in Q3.

We now have 15.6 million members all of whom have purchased in the last 24 months.

We're utilizing the purchase database associated with these Rewards members to develop a deeper understanding of our customers preferences and that in turn is dictating our precision marketing efforts.

Based on the customer traffic stats I mentioned earlier, these precision marketing efforts appear to be working quite well.

In the Real Estate arena several things are happening.

By the end of this year we will have remodeled 28 stores and removed the clearance walls in 34 stores.

In 2011 we will remodel approximately 30 stores and remove clearance walls in another 30 stores.

We also opened up four new stores in the third quarter.

These stores are located in Staten Island, New York, Danbury, Connecticut, Scottsdale, Arizona and Salem, New Hampshire.

As a group the stores are performing exceptionally well and exceeding their sales plans by a wide margin.

In 2011 we plan to open approximately 20 new stores.

Three of these stores will be in small markets which will give us the opportunity to test our ability to be financially successful in markets that we have avoided in the past due to population size.

As I mentioned on the last call, if this small market test is successful, it opens up the opportunity for at least 50 additional markets for us.

In the area of systems, we're on track to implement our Stock Locator System in many of our stores by the end of 2010 with the rollout finishing in the first quarter of 2011.

This system will allow us to do look-ups of wanted sizes at store level in order to improve the customer experience and maximize conversion.

In 2011, we have a number of additional systems initiatives on the docket.

The one that we're most excited about is size optimization which will allow us to develop insight into differing size profiles by store and then orient our size assortment in each store to conform to those profiles.

In 2012, we'll begin work on an assortment planning tool which will fundamentally change the way we build assortments by store.

So to summarize, we enjoyed good financial results in the third quarter and we have a number of initiatives in flight that can improve our results further in years to come.

On the other hand, our business is not without threats.

One of those threats is the specter of higher product costs coming out of China.

I'm sure you've all read about the labor shortage and rising raw material and manufacturing costs for goods produced in China.

This is important to DSW because the majority of our products both Branded and Private Brand are sourced out of China.

We're tackling this potential problem proactively.

Our Vice Chairperson, Debbie Ferree, and her top merchant and supply chain teams just returned from a 10 day trip to China to meet with our key suppliers.

They learned a great deal from these meetings and came away believing that although we will not be able to avoid cost increases all together, there are several tactics we can employ to mitigate these inflationary pressures.

And with that I'll turn the call back over to Leslie.

Now to the question-and-answer.

Please limit yourself to one question and one follow-up in the first round.

This way we will have a better chance to get to each questioner.

You're welcome to get back in the queue in the same manner you did originally.

Noellia, could you please instruct how the callers can indicate a question?

Thank you.

(Operator Instructions)

Your first question comes from the line of Scott Krasik from BB&T.

Hi, good morning, everyone.

Good morning.

Congratulations.

Just first question on the 20 - - good to see that you are accelerating, the store growth shows a lot of confidence.

Maybe talk about the size of the 20 stores that you're opening ex the three in the small market.

Or maybe explain the differences between those and what you expect out of the new stores.

Sure.

First of all, I think that the thing that's happening is a lot of deals are coming our way for attractive real estate opportunities, that's really what's changed.

And we're just taking advantage of that.

I think we're becoming a more favored tenant in a number of different shopping center situations.

All of the stores that we will open next year will conform to the 17,500 square feet or larger prototype.

The difference in the three small markets is that we've been able we believe to strike real estate deals that will allow us to afford the bigger space that hopefully we can grow into, but initially we will probably not stock them as fully as we might have with a - - for a store that would generate significantly more volume.

So we believe if it's successful it can represent the best of both worlds.

And in terms of productivity you should be at or above the level you're seeing now in the stores you've opened?

It's possible that the sales productivity in these small market stores could be slightly lower than what we would have in other markets.

But I think because of the real estate cost we can offset that.

Okay, and then Doug maybe just talk a little bit about what your expectations are for merchandise margins and buying and occupancy leverage over the next few quarters?

You've done a great job with tough comparisons so far.

Yes, and although -- thanks for calling that out.

I'm glad you noticed that, but they are slightly lower than last year in the third and expecting to be so in the fourth quarter.

But as Mike mentioned in the script and Debbie has a lot of focus on right now is the increasing cost pressures that we're likely going to see in the back half of the year.

So we do have a lot of things going on to mitigate those things - - those cost increases.

But we do see based on the high level of achievement in 2010 that will be a tough number to anniversary.

But again the mitigating factors that we have in our plan should be able to generate flat or maybe even some improvement in 2011.

So from your perspective, that scenario which you outlined for us a quarter or two ago about big decreases year-over-year, even with some of these pressures, you expect to be able to do better than that for next year?

On an annual basis.

Obviously, the big pressure starts to come in the Fall season.

Okay.

All right, thanks very much.

Good luck.

Your next question comes from the line of David Mann from Johnson Rice.

Yes, thank you.

Congratulations.

Mike, you've been here for a little while now and obviously done a great job with the team.

I'm curious when you and Doug put together the plan longer term, in the past management had talked about 30, 20, 10 kind of margin cost and EBIT structure.

Can you give us a sense on where you think those numbers can go and what we should be thinking about?

Sure.

I think we said it was really tied to the sales productivity of our stores.

And I think we've mentioned that if we could get somewhere between 235 and 245 a foot in our stores that we could probably achieve that 30, 20, 10.

And I think if you look back on the last four quarters, our sales productivity in our existing stores is -- I think it's around 220.

So - - it's not out of the realm of possibility.

I was not the author of that 30, 20, 10 prediction.

I think Doug Probst was but he is with each passing quarter he's proving to be prophetic.

And then for our follow-up, I'm just curious if you could - - given these tough comparisons when you start looking at next year, can you talk about your - - what factors you think will help drive comp store gains, if you believe you can get gains?

And then secondly, Doug, if you can talk about what your leverage point on operating expenses will be in terms of comps?

Okay, I'll start.

Third quarter was big for us, because we were not sure that, at least until we proved it, we were not sure we could generate big comps on top of really big comps.

And obviously we were able to do that.

And I really do believe it was due to the three factors I mentioned; increased recognition, increased relevance and better execution.

And I think those same factors should help us as we move out of 2010 into 2011.

Obviously, the number of consecutive quarters where we generate big double-digit comps is going to make each successive quarter that much harder to generate large comps.

But at this point we wouldn't see any reason why we couldn't generate some level of positive comp in 2011.

And if we're able to do that we ought to be able to incrementalize earnings as well.

And we obviously haven't finished our budgeting process but that's our view right now.

And Doug if you want to add anything on leverage?

Yes, as we look toward 2011, we're obviously still in the final stages of preparing that final budget and plan.

But our usual perspective on leveraging SG&A centers around a comp of about 1% to 2%.

And while that's normally true given our planned investments in new stores as well as IT this year, we don't expect that a 2% comp is going to generate SG&A leverage, but certainly anything north of that probably would.

So traditionally it has been about 1% to 2%, but in 2011 based on those investments we think it's going to be slightly higher than that to get leverage in SG&A.

Thank you, very helpful.

Your next question comes from the line of Chris Svezia from Susquehanna Financial Group.

Good morning, everyone.

Great job.

I guess, Debbie, a question for you.

When you think about as you kind of took a first blush and start thinking about Spring, just maybe some of your thoughts in terms of what you might be seeing, maybe some key drivers, anything new that you see emerging out there for Spring 2011?

Chris, this is Debbie.

So yes, I'm pretty excited about Spring actually.

We've just come off two major shoe shows where we really had a chance to evaluate the market and really make a decision where we're going to dig our heels in.

And the first thing I'm excited about is as we cross this January into February, so the February DOT forward-facing inventory position, our inventories are positioned in a very, very strong way to be able to capitalize on some of the new trends.

As we have I think done a pretty good job cleaning up any slow-sellers and any tail ends of the Fall season, so the inventory mix is very strong going into Spring.

As far as the trends are concerned, there's a lot of exciting things that really haven't been out there that aren't in the Women's closet or the Men's closet and that's when you really have some nice strong sales and comps that you can look forward to.

What are some of those trends?

The whole Americana trend I think is probably the biggest one that we're seeing, which is really a trend that crosses both genders, both male and female.

And that's the very cleaned up kind of preppy kind of look that you're seeing in Americana.

The other trends I feel very strongly about are vulcanized wedges which kind of encompasses the whole natural and neutral trend.

Vintage which just continues some of the new materials, the brushed materials and the veg leathers are really exciting new materials that are going into not only casuals but also dress shoes, which really hasn't been out there in a major way, Lace-ups and City Sandals.

So as you can see, there's a lot of trends here that we're talking about that we weren't talking about last Spring which like I said really goes for a kind of exciting opportunity for the Spring season.

Okay.

Thank you, and then just on the Men's side, you've had pretty consistent performance there in terms of comp growth, in terms of size replenishment was there, I think you've made some changes in terms of the management structure about a year ago there too.

Any thoughts about sustainability in that category?

And any color I know on the Men's side with regard to Nike and Athletic?

Early stages but how do you see that maybe evolving as you go into next year?

Do you increase the skews?

Does it become more technical?

Just sort of your thoughts there.

Yes, so let me just start with the overall Men's business.

Men's as we talked about, Chris, on the last earnings call, is still right around 14%, 15% penetration and at its high many years ago, it reached 19% to 20% penetration, so there's still a lot of runway ahead of us in terms of Men's growth.

In terms of how we've changed the mix, remember that approximately 18 months ago we've put a new strategy in place which really incorporated a new infrastructure where we put a new GMM into that role and also we've started changing the mix.

How do we change the mix?

It typically was mostly classic and traditional and we changed it to more of a balance between fashion and classic traditional.

In addition to that, we took our core skews and that's about 30% of our styles that we've put on size replenishment.

So we have a new management infrastructure, you have a strategy that is really taking hold now as it's been in place - - almost 12 months and then you have a better balance of mix and assortment.

In addition to that, there's some new efforts that we're making obviously in the Athletic piece of Men's and that's Nike.

There's a lot of exciting things happening in Athletic, so it's the addition of Nike of which we're very pleased with our early results.

But we're also pleased in the Athletic area in Men's because the whole technical piece of the business which we've really had more of a lifestyle fashion piece of Athletic, now we've balanced it more between technical and fashion.

That whole new piece, the technical piece is taking hold for us as well.

In addition to that we're going to start testing some marketing efforts.

We're not quite sure exactly specifically what we're going to be doing here but we are starting to test the water in marketing so that we can try to attract more and more male customers into DSW and speak specifically to them.

As you know, our overall marketing strategy is more of a brand strategy and speaks primarily is Women.

We're going to give Men's their due share and throw some money that way to try to test the waters and see if we can increase the traffic and the conversion in them.

Okay.

Sounds good.

Best of luck to everyone.

Thank you.

Thank you.

Your next question comes from the line of John Zolidis from Buckingham Research.

Hi, good morning, great results.

Thanks.

A question on the balance sheet, the cash that you have there.

It's quite a substantial treasure chest of cash.

Is there anything that prevents the Company from doing more with this cash to benefit shareholders?

Can you just kind of go through what may be holding you back from either paying a dividend or buying back stock or making an acquisition?

How do you guys think about the impact on your returns for shareholders of keeping such a large cash balance?

Thank you.

Yes, John.

It's a good question and quite frankly over the last couple of years, our focus has been on the business and building this cash is a result of that focus.

So now that the levels of cash are going up north of $300 million, we're looking at all the traditional things.

And there is nothing preventing us from doing some of the ideas that you suggested.

I will tell you as we look at acquisitions, that will be very important for us not to distract ourselves from the main DSW business which we've been pretty consistent in saying.

But as far as some of the other capital structure ideas of dividends and buybacks and those sort of things there's nothing to prevent us and we are looking at those as you might expect to generate the best shareholder return we can.

Okay, so just to clarify, the RVI relationship, there's nothing about that that stops you from share repurchase or dividends?

We consider every element in those decisions, but I'm not going to comment on RVI.

But there's really nothing holding us back from the decisions on capital structure.

Okay, great.

Thanks and good luck.

(Operator Instructions) You have a follow-up question from the line of Scott Krasik from BB&T.

Hi.

Thanks, again.

Debbie, noticeably absent from the discussion so far has been Toning.

I know you guys have done a pretty aggressive job of minimizing that part of your business.

Maybe talk about what you're actually seeing there though still, what are customers coming in, are they still buying the same number of units, just at a lower price?

What's the interest there and what's your plan for it in Spring of 2011?

Thank you for that question.

So Toning is still a very relevant part of our business.

It still is tracking at about 2% to total Footwear and approximately 12% to our total Athletic business.

Going forward, it looks like it may go down just a little bit in terms of penetration.

The pairs actually that we sold in Q3 was pretty consistent with the kind of pairs we sold Q1 and then in Q2.

I think what you're going to see here is the new products are really taking hold.

The bigger bottom, the rocker bottoms that the Toning craze really started with, that's minimized now to a great degree and all the excitement seems to be in the new products that are coming in in Toning.

Margins in Toning are coming more into line with the Athletic department as everyone is trying to exit out of the non-go-forward styles and test the waters on the new products.

I will tell you that my big focus going forward like I said--2% to total Footwear and 12% to total Athletics is nothing to sneeze at.

But my big focus going forward is more on the lighter-weight Footwear, which is really the new focus and the new trend in Athletics.

So reducing the ounces of the shoe and just a lighter-weight more of the barefoot Running and lighter-weight Footwear.

So that's really where my eyes are focused going forward, although Toning is still an important part of it.

And just relative to units and ASPs for the first half of next year, I mean that -- should this business be flattish, down a little?

What's your, if you incorporate all of the lightweight and all of that stuff?

So the comp in the Athletic business have been holding quarter-by-quarter pretty consistently at double-digit comps.

I still think that there's an opportunity to maintain in the high single- and low double-digit comps in Athletics only because there's a lot of newness happening in Athletics and I'm pretty excited about what I'm seeing.

As far as the Toning piece is concerned, the penetration of that product as I said will go down as a percent to total Footwear and also as a percent to Athletics.

And then the increase, all of the growth will be coming out of technical and the lighter-weight.

Okay, that's helpful.

And then just lastly, a few months ago you mentioned that you had some good reads on Pumps in Women's for Spring.

And you didn't mention that I think when Chris asked the question, is that a trend that you don't see actually playing out or should that still be the case?

Sure.

As we said in third quarter, the Women's business was up around 10%.

Dress business was up 5% and Plain Pumps was up 17%.

So we did see Plain Pumps slowdown just a little bit, but now in third quarter they seem to have come back around again.

So I think the key is to keeping the Plain Pumps fresh.

I'm seeing single-sole dress shoes come back into the fold that haven't really been important in the past.

In the past 12 months it's been more about aggressive bottoms and platforms.

So I think the introduction of single-soled has helped the comps and then keeping on the more aggressive platform some interesting materials and we will keep that fresh as well.

So I think plain pumps, I don't really see why it's going to slowdown from where we see it right now.

Although there's a lot of new, exciting things as I just mentioned in some of the Spring trends going forward.

But no, I'm pretty excited now about plain pumps.

Okay, thanks.

Your next question is a follow-up question from the line of Chris Svezia from Susquehanna Financial Group.

Thanks.

Just I guess two questions.

The first one, just Mike, your comments with regard to product costs and the inflationary pressure that's coming.

Maybe you could just talk a little bit about when you see that impacting your buys?

And any color about what you're doing to mitigate that, understanding I guess that it's an industry-wide phenomenon.

And I guess it's going to be raising all those in terms of the pricing pressure.

Is it just a matter of DSW maintaining the value presentation to customers?

Is that what you're talking about?

So I'm just wondering if you can talk a little bit more about what your thoughts are there and what you're doing to mitigate that.

Chris, I'm going to let our expert, Debbie Ferree take that one.

Okay.

So, Chris, the first thing I will tell you is first and foremost is that our value proposition is very, very important in DSW.

And that's the first and foremost thing we always have to think about in buying goods and when we price goods.

Having said that we are seeing some pricing pressures as most retailers have.

For the Fall season, what we talked about is cost increases on the low single-digits.

And that's kind of what we realized in the Fall season is what we're looking at in the Spring season.

We haven't yet been to the trade show.

That's next week in New York to see what next Fall is going to bring.

But we're hearing increases, we're hearing about them anywhere from the high single-digits to the low double-digits.

Now, having said that, I think there are many things that we have an obligation to our customer as a value provider of footwear to do, and that is on our commodity items, we're going to look to maintain our retails on our big, must-have commodity items.

How do you do that?

I think you have to work very closely with the manufacturers.

You have to understand what their pressures are and what the opportunities to work those prices down are.

What are some of those opportunities, being more planful about the units, the pairs that you will use over the course of the next year, so better planning in terms of your capacity and your needs.

Number two, looking at the kind of materials that you use for different parts of footwear and understanding that perhaps if you do a big leater buy -- a big material buy with a manufacturer and try to help him buy leather at the lowest possible price and at a time that is best for him to get a better cost that we will use that leather over time in different kinds of shoes and constructions.

So I think there are things that we can do from a store thing and a technical point of view that if we work collaboratively with our retail -- our wholesale partners that we'll be able to mitigate some of those costs.

The other thing that we're doing is an opportunistic buy.

Opportunistic buys you can usually get at a much better discount than you can a normal, in-season product.

And so I think to be able to leverage an average cost that is better for retail and how we price goods.

We'll be able to leverage those off-price buys with the in-season buys and come up with a better average cost and then be more sensitive and pass that value on to the customer.

So did that answer your question?

No, it's helpful but I'm assuming in outside of commodity-type items and special buys, you'll be continuing to negotiate with your key suppliers in terms of mitigating that cost in any way whether it's just in terms of the scale you're buying or negotiating those deals.

But at the same time, is it fair to say that directionally, there will be a slight bias overall in aggregate to see a slight increase in pricing across-the-board.

Some areas you'll be able to negotiate flat, some areas you'll have to eat some of the, I guess some of the costs.

But for all intents and purposes, pricing more than likely at DSW should incrementally move up in aggregate?

Is that a fair assumption?

Costs are going up, there is no question.

And we're going to have to look at specific places where retails may elevate.

But our retails will elevate in the same way that you're going to see retails elevate across the entire industry.

Okay.

So we're not going to be - - we're not going to look out of proportion or out of sync with what's happening across the entire retail sector.

What we're going to do is we're going to work closely with our manufacturers.

We are looking to mitigate those costs as best we can, those cost increases.

But the one thing I don't want to do is I do not want to compromise quality in our product and just lower cost prices and put a less than stellar quality product on our selling floor.

The first person that will vote on that will be the customer and you'll get dinged pretty bad if you do that.

Right, no, understandable.

And then the last question I have is just one for you, Doug.

Just going back, I think Scott had mentioned this earlier.

I just want to understand this for one second.

If you think about as you anniversary 2010, you think about 2011.

I think you made a comment that the merchandise margin would be I guess difficult to comp.

I guess I'm just trying to understand the puts and takes, if we were to assume that the merchandise margin might be a bit challenging, hopefully maybe you can do better?

Is it fair to say -- and when you talk about SG&A and you made a comment about better than maybe 2% to leverage.

Can you maybe talk also about occupancy and where that might fall into the fray in terms of what you need to do to leverage that piece of the business as well?

So you've hit on all of the points and on the occupancy piece, positive comps is going to generate some leverage in that category as well as our distribution and fulfillment centers as that starts -- as the dot com business continues to grow that expense starts to leverage as we get more efficient there.

And some of the anniversaried cost of initiating our size replenishment program so we should have some leverage in that arena as well.

So positive comps of any sort helps those categories.

And then the other element of course is 2010 was a very good year, so anniversarying or comping those numbers are a little difficult.

But again, some of the items we talked about in mitigating the higher cost perhaps coming out of China, we have ways of maintaining that or maybe even getting some improvement on the merchandise margins depending on the mix of sales and some of the other trends that develop in the back half of the year.

So I'm glad you called out the fact that our gross profit, the one that externally is reported, includes merchandise margin as well as occupancy and distribution center costs which we can get some leverage with some positive comps.

Okay.

All right, thank you very much.

Appreciate it.

Your next question comes from the line of David Berman from Berman Capital.

Guys, great numbers.

Just a quick question for you.

Everything has been asked.

Just curious, your prepaid expenses were up about $7 million, it's a 33% increase and SG&A was kind of flattish.

Well done, that's a great controller of SG&A.

So I was just wondering what that was for?

We're going to follow-up with you.

Quite honestly we weren't prepared to take that question and disclose exactly what that balance is for.

But some of it is related to how we acquire some merchandise with two particular vendors, that we give some advance payment to some vendors before we actually take ownership.

But there's some other categories that we can refine with you.

So if you wouldn't mind I'd like to follow-up with you.

Yes, that's fine.

No problem, no problem.

And just a reminder for the Board that for one-time dividends, the tax rate probably goes up next year, so if you're going to do something with one-time dividends this is the year to do it.

Well, there's some thought on that, that's right and that was also considered in our capital strategy.

All right, well thank you very much and congratulations.

Thank you.

Your last question is a follow-up question from the line of David Mann from John (sic) Rice.

Yes, that's Johnson Rice.

Can you talk about the performance of the remodel, just update us on how that's going versus your previous comments?

Yes.

It's a little early and I might say that we're still tinkering with our new store prototype that -- many elements of which we incorporate into our remodel.

So what we expect out of those remodels is mid single-digit sales lift versus what they would have done without the remodel and -- I expect that we'll achieve that.

It's a little early on the ones that we initiated this year just because there's been very little time that's passed since their completion and some are still in process.

Okay.

As to the clearance walls, I also mentioned that we removed clearance walls and you may recall that's for a few reasons.

One, it increases the impression of size that the customer gets when she comes into our store.

Secondly, it opens up a really, really important part of our value proposition which is our clearance racks.

The third thing is it's easier to cover the store in terms of customer service.

And the fourth thing is it will improve our shortage rate simply because it's harder for non-paying customers to hide merchandise when they're out in the open.

So those are all of the things we expect from it and we have, it's early but we have seen a small lift in sales as well when we open up those clearance walls.

So a little bit early on both of them but the early signs are promising.

Okay, and in the past when you talked about the store network, I think you've elaborated that there's been a gap in sales productivity.

Can you update us on how the buckets of stores are performing and if that gap is still fairly large how would you close the gap?

David, I'm sorry, I missed the first part of your question.

It was a little quiet.

In the past I think you've elaborated several years ago that there was a pretty big gap in sales productivity, a different variation within the store base.

So I was just curious if you could elaborate on what the variance in productivity might be again as you are sort of approaching your historical productivity on average?

And then what might you do to close that gap?

Well, as I look back at the results over the last 12 months on sales productivity and the comps in each of those stratified stores everybody's raised about 12% to 13%.

So the acceleration in comps that we've seen here hasn't come from a certain group of stores as it relates to productivity so they are all rising if you will.

So and again, as you know, historically we don't have any stores that are hurting us in any significant way from a P&L and certainly from a cash perspective.

And if we had any they would have either been closed or impaired.

So we look to all stores having opportunities and sales productivity and that's going to come through comps and it seems to play out that way so far in 2010.

Thank you.

Ladies and gentlemen, this concludes our question-and-answer session.

I'd like to hand the call over to Ms.

Leslie Neville for closing remarks.

Thank you very much for joining us today.

As always, we will be taking follow-up calls all day today at our home office.

Thank you.

Thank you for your participation in today's conference.

This concludes your presentation and you may now disconnect.

Have a great day.