Designer Brands Inc (DBI) 2016 Q2 法說會逐字稿

Good morning, and welcome to the DSW second-quarter 2016 earnings conference call.

(Operator Instructions)

Please note this event is being recorded.

I would now like to turn the conference over to Christina Cheng, Senior Director of Investor Relations.

Please go ahead.

Thank you, Andrew.

Good morning, and welcome to DSW's second-quarter conference call.

Earlier today, we issued a press release detailing the results of operations for the 13 week period ended July 30, 2016.

Please note that various remarks made about the future expectations, plans and prospects of the Company constitute forward-looking statements.

Actual results may differ materially from those indicated by these forward-looking statements due to factors, including those listed in today's press release, and our public filings with the SEC.

Joining us today are Roger Rawlins, Chief Executive Officer; Deborah Ferree, Vice Chairman and Chief Merchandising Officer; and Jared Poff, Interim Chief Financial Officer.

Let me now turn the call over to Roger.

Thank you, Christina.

With our focus directed towards driving the DSW brand, I've spent several weeks during the last quarter visiting stores in every region of the country.

After spending a good deal of time with our customers and field associates, we believe there are many opportunities for improvement, as well as many exciting avenues for growth.

These visits have strengthened our belief that no one else out there really owns shoes like we do, offering one of the largest best-stocked assortments at compelling prices, every day.

By focusing on our core, and capitalizing on our strengths at Designer Shoe Warehouse, we will increase customer loyalty and grow the business.

Despite the challenging second quarter, we are solidly on track to deliver the full year within our guidance.

We ended the spring season clean from an inventory perspective, by moving through slower moving inventory with successful traffic-driving promotions.

We are making significant distortions to key trends for the fall season, and tempering our seasonal exposure in boots.

In addition, we made progress in a number of initiatives to drive higher quality sales and restore profitability in the back half.

We've created new vendor partnerships both with national brands and private brands, and launched the new kids category.

We've also streamlined our organization and business processes which will reduce expense growth, and align future capital spending with our strategic priorities.

As with any restructuring, the process was difficult, but necessary.

I want to thank all of our associates nationwide for their focus, accountability, and passion to succeed.

Let me turn the call over to Jared for a brief recap of our financial performance.

Thanks, Roger, and good morning, everyone.

I'm glad to be here today.

While our metrics during the quarter remained below LY, our performance improved for the first quarter -- from the first quarter, and is expected to continue improving throughout the fall.

Revenues for DSW Inc.

increased 5% from LY, driven by new stores and Ebuys, offset by negative 1.2% comps.

Sales trends continued much as they were in Q1, but we experienced better transaction activity as our marketing and reactivation campaigns drove traffic, which outperformed the index to a greater degree than in Q1.

We deployed tactical local marketing that improved the performance, and closed the gap between a number of underperforming districts and the rest of the chain.

I was happy to see us react with tempo and actions that produced the intended results, and generated incremental margin dollars.

We continued to see results from our investments in omnichannel, with digital demand growing by 21%, and a significant majority of our omni sales being fulfilled from our stores.

We opened 3 new stores during the quarter and closed 1 store, resulting in 12 net new stores year-to-date, compared to 18 last year.

We expect to open 21 stores during the fall season.

At the end of the quarter, we had 480 DSW locations in the United States.

Comps at the ABG segment declined by 1% as well, with a total of 385 locations at the end of the quarter.

And finally, our newest investments, Ebuys and kids both contributed to our sales growth, with kids being launched near the end of the quarter in 206 stores and performing to plan, and Ebuys growing revenues at a healthy double-digit rate.

Moving to gross profit, while our sales increased to LY, our gross profit dollars and rate declined to LY driven by lower initial markups, marketing markdowns to drive traffic, and the fact that Ebuys business model operates at a significantly lower gross profit rate.

While much of this gross profit pressure was similar to Q1 albeit on a slightly improved trajectory, we expect to see the trend improve, with gross profit dollars at the DSW segment beginning to exceed LY during this upcoming fall season.

On operating expenses, we continued to exceed LY both in dollars and rate, but we did improve materially from Q1 by holding store expenses, and reducing home office growth, despite increases in marketing and technology spending.

Additionally, Ebuys which operates at a much lower operating expense rate provided leverage -- SG&A leverage.

As a reminder, adjusted operating expenses exclude $2.7 million of restructuring costs, and $3.9 million of acquisition-related expenses.

All of this resulted in our adjusted operating income falling below last year by $[13] million.

Our investment in Town Shoes of Canada contributed $418,000 in investment income this year, reversing from the loss of $230,000 last year.

Town did not open any new DSW locations this quarter, and we have a total of 17 DSW Canada stores today.

Our tax rate was slightly higher due to favorable discrete items last year resulting in reported earnings of $0.30 per share, which included $0.02 from one-time restructuring charges, and another $0.03 from purchase accounting and fair market value accounting for the contingent consideration of Ebuys.

When adjusting for these items, our adjusted earnings were $0.35 per share.

Turning to the balance sheet, we ended the quarter with cash and investments of $244 million, compared to last year's $471 million.

The lower cash balance reflects our investments in Ebuys last quarter, and our share repurchases last year.

We did not repurchase any shares this quarter.

Excluding inventories from Ebuys, inventories were flat on a cost per square foot basis.

We worked hard to make sure our inventories were clean coming out of the second quarter, with investment for kids and athletic offsetting lower pre-buys.

Clearance inventory was lower by 6% this quarter, and with our current sales plan, we expect lower selling inventory levels throughout the fall season.

Capital expenditures for the second quarter totaled $26 million, with $10 million spent on stores and the balance spent on technology and business projects.

In conjunction with our expense review, we are lowering our target capital budget from $95 million to $85 million, with a lower number of store renovations and technology projects.

Turning on to guidance.

Our second quarter performance puts us solidly on track towards our outlook of $1.32 to $1.42 per share.

We have maintained our outlook for a comp decline in the low single-digits.

With this, we have positioned lower receipts in the fall that will allow us to chase the upside as the business unfolds, while minimizing markdown risk.

Additionally, we are continuing a similar level of marketing, but targeting significantly lower markdown activity during the holiday season.

As a result, we expect total Company gross profit to improve from the 230 basis point decline we experienced in the spring season, to a flattish level in the back half.

In addition to buying more conservatively, we have taken actions to help shore up profitability going forward, and in fact, a number of our initiatives have begun to benefit gross profit this quarter.

Our order routing algorithm continues to optimize store fulfillment of digital orders.

We are improving sourcing costs through better vendor accountability and stronger negotiations, and we expect that increasing the depth of key item buys will lower unit costs, improve in-stock levels for high velocity items, and ultimately lead to higher realized margin.

Finally, as we roll out new private brands under our new partnership, we expect this program to become more meaningfully accretive next year.

As Roger mentioned, we completed a comprehensive expense review this quarter, and identified approximately $25 million of annualized cost savings from organizational realignment, procurement, and business process improvements.

Approximately 30% of these cost savings will benefit 2016, and were already factored into our guidance.

These cost savings will reduce our operating expense growth from 8% year-to-date to a mid single-digit growth rate in the fall season and enable us to keep our SG&A rate flat, despite a $9 million headwind from incentive compensation, and negative low single-digit comps.

Following the 21% earnings drop during the front half, we are working hard to improve profitability after last year's difficult fall season.

With conservative planning assumptions and a modest increase in marketing, our guidance assumes a mid single-digit earnings growth in the back half of the year.

We have much to accomplish to get back on the path of steady growth, but we are committed to delivering a consistent and sustained earnings growth go forward.

With that, let me turn the call over to Debbie who will recap our category performance.

Thanks, Jared, and good morning, everyone.

I was encouraged with the traction we saw in parts of our business during the quarter, and we are maximizing several opportunities to drive sales, lower markdowns and improve profitability.

The combined women's athletic and non-athletic comp was in line with the DSW segment.

As the demand for athletic continues its momentum, we increased our total athletic penetration by more than 200 basis points this quarter.

We've also expanded our women's athleisure offerings with a broad number of fashion sport brands which added another 500 basis points of penetration toward the athletic lifestyle this quarter.

I was excited by the results and the new fashion looks in dress which produced healthy positive regular price comps.

The increased demand for dress sandals, coupled with less favorable weather mid season tempered the demand for seasonal sandals, ultimately resulting in a flat comp for the total sandal business in Q2.

Although our sales plan anticipated this to a degree, we reacted swiftly and exited the season clean.

In the men's area, the combined athletic and non-athletic comp was also in line with the chain average, with athletic outperforming the balance of the department.

We continue to shift resources into key brands and styles that support the fashion casual lifestyle.

We have assembled our strongest athletic assortment this fall season, including styles from some of the biggest brands in the athletic space, and we are significantly increasing the amount of exclusive merchandise this year.

We are also pursuing a number of initiatives that will elevate DSW as an important destination for the fashion athletic consumer in the coming years.

While comps in our accessories category continue to be depressed, we improved gross margin rate by close to 200 basis points.

We continue to explore ways to leverage our accessory and giftable areas to increase units per transaction and average dollar sales.

Finally, after a successful two-year pilot, we are excited with the launch of DSW kids to close to half our chain.

As I visited stores, and walked through our new kids section, I am convinced we have the most exciting, robust, and differentiated kids assortment found in the marketplace today.

It looks great, and customers are voting with their wallets.

Our reads are still preliminary at this point, but so far the launch is tracking to expectations, with improvements in traffic, attachment rate, and higher units per transaction post launch.

Over half of our rewards members have a child in their household, and this category provides an important vehicle to acquire new customers and wallet share.

I'm pleased with the 2016 fall assortment, which will allow us to tell many compelling product stories.

We're securing several exciting, must-have national designer brands that will be showcased throughout a number of special events and compelling deals every day.

We're increasing the frequency of product-oriented messages, while at the same time highlighting the value our customers can find with our regular and clearance assortment.

Lastly, we continue to evolve our private brands that are resonating very well with our customers.

We're adding a new men's private brand which will appeal to the young, fashion-conscious consumer, as well as adding a new line of affordable fashion for girls this year.

By evolving our private brand collection, we will offer more differentiated and exclusive products at significantly enhanced profit margins going forward.

Now let me turn the call back to Roger.

Thanks, Debbie.

Product is the heart of DSW's value proposition.

As we discussed last quarter, we continue to focus our energy on elevating and differentiating DSW's product offering, while capitalizing on new ways to expand customer access to the entire assortment.

With the inventory now accessible across the network, we're increasing the number of choices a customer can conveniently access from roughly 2,500 choices in an individual store, to over 30,000 choices across the enterprise.

We are increasing the depth of our key items for fall to ensure that our best-selling products are consistently represented across our entire fleet of stores.

By increasing availability of our best-selling items, we will improve customer conversion, leverage scale and improve our sourcing costs.

We are exploring ways to increase our physical store capacity, in order to amplify category distortion, and increase choice counts without impacting the existing assortment.

We distorted our athletic assortment at a small number of test stores, and doubled the athletic penetration in a short period.

What we saw was when we offer more athletic choices to the customer, we sell more athletic products.

So the real challenge now is to figure out how do we maximize the athletic assortment in our stores, without impacting the balance of the assortment.

This is critical for optimizing future category distortions, as well as growing our kids assortment to the rest of the chain.

Our efforts to elevate our assortment are also starting to produce results.

We are starting to showcase exciting opportunistic buys from several highly desirable brands and based on the level of digital engagement and sell-through data, we know these events are activating many customers who love these brands.

We've entered into a new private brand partnership that's going to elevate our offering, and improve our ability to stay fresh with merchandise that can be found only at DSW.

Additionally, we expect our sourcing costs to benefit from the large scale this partnership brings, and enhance product margins over time.

We're already experiencing some of these benefits today, but expect to start seeing the bulk of these benefits materialize in 2017.

In addition to elevating our product and value offering, we're creating new brand experiences inside and outside the store.

We're accentuating the warehouse experience, a core pillar of Designer Shoe Warehouse, not a warehouse in the traditional sense, but a warehouse at the front of the supply chain, where the customer can find the newest and best products, at an incredible value.

With 70% of the US population living within 20 miles of a DSW store, we have a competitive advantage in speed to consumer, and instant access to our expansive assortment.

As you can see, we are building on the strengths of the DSW brands, and leveraging the investments we've made.

I am confident these steps will improve the sales productivity of our existing fleet, and enable the DSW brand to grow through a combination of comp sales growth, a measured pace of store expansion, and continued digital growth.

In addition to some of the exciting things we're working on right now for the DSW brand, we're also planting the seeds of future growth in new markets and new channels.

With our Ebuys acquisition, we're working together to share with our vendor community how DSW Inc.

now offers a broader and more efficient channel to manage inventories across the product lifecycle, while at the same time helping them to preserve and enhance brand equity.

We continue to explore our options to grow internationally.

Town Shoes of Canada is expanding DSW's footprint north of the border, towards 45 to 50 targeted locations over time.

Additionally, based on the 3 million international customers who have shopped at DSW, we believe there is a significant opportunity to grow outside North America.

We are excited to partner with the Apparel Group, one of the leading franchise operators serving the Middle East.

We expect to open our first two stores in 2017.

I am confident the Designer Shoe Warehouse concept will resonate strongly in many parts of the world, and the franchise model provides us the best platform for now to expand internationally.

In summary, I'm excited with the traction we're gaining, and the trajectory in which we are heading.

We're building on a foundation for a strong brand, and a leaner, more efficient organization.

Lastly, we are laser-focused on driving growth through the DSW brand and our entire portfolio of retail banners, proprietary brands, and ABG partners.

I look forward to reporting our progress next quarter.

I'll now turn the call back to the operator for Q&A.

(Operator Instructions)

Paul Trussell, Deutsche Bank.

Hey, good morning, and nice quarter.

I just want to just follow up on the guidance for the balance of the year.

By a lot of measures, you've outperformed in the second quarter, and it seems like you found additional cost saves for the second half.

And so, I just want to understand the reiteration of the guidance, kind of the puts and takes there?

And very specifically, if you can discuss what your merchandise margin and comp assumptions are?

Thank you.

Sure, this is Jared.

For the comp assumptions, we are assuming a low single-digit comp decline, which I believe is relatively in line with what our guidance was previously.

From a merch margin standpoint, what we are expecting is, to see a significant improvement in our markdown rates.

So as we mentioned before, we have slowed our inventory receipts down compared to last year, and we are expecting to not to have to anniversary the clearance events that we were -- we had to do last year in the fourth quarter specifically, but throughout much of the fall season.

So that should enhance our markdown performance.

So overall, we're expecting a slight decrease in our overall gross profit rate, but it's materially improved from what we had been experiencing in the first half of the year.

That's helpful.

And just a quick follow-up for Debbie.

Just maybe discuss your outlook for women's business, particularly boots, as we go into the fall season?

Sure.

Good morning.

So we're planning a conservative approach for boots in the back half of the year.

We've gotten many questions in the past, how do you weatherproof the business?

And we feel that planning the boot category at a more conservative plan, will actually help that situation.

I'd rather go in leaner, and chase what the customer wants, rather than go in with an aggressive plan.

So penetration in boots will come down slightly, whether it materializes like that, we'll let the customer vote, but it's planned down, in probably the low to mid single-digit comps for the back half.

The penetration is planned down slightly, as our categories start to take hold, like athletic for example.

So that's how we're looking at the back half.

Thanks for the color.

Good luck.

Thank you.

Tom Nikic, Wells Fargo.

Hi, everybody.

Thanks for taking my question.

I was wondering -- sorry if I missed it, did you give the breakdown of the comps by different categories, men versus women's versus athletic versus accessories?

(Multiple Speakers).

Would you say that again, Tom?

Yes, I was just looking for the breakdown of the comps by the category, men's versus women's?

Sure.

So for Q2 what we delivered was a down 3.9% in Q2.

That's fairly consistent with what the Q2 delivered.

The way I'm looking at the business now though, is if I add women's non-athletic, and then I add the women's sport piece in the athletic business, I'm looking at a down 1.5% which is the consistent with Q1.

So a couple of highlights in there, would be dress is -- was up, which was good.

Casual was down a couple of points, with fashion and sport significantly comping in high double-digits.

And sandals, as we talked about earlier, the casual sandal was down in the mid single-digits.

So women's was down 3.9%.

Men's was down 4.3%.

If you factor in the athletic piece of men's into the men's business, it would have been down 1.5%.

Athletics was strongly up 13.5%, and that's been strong double-digits consistent with where we've been seeing it perform.

And kids is not really relevant to talk about, because as we launched another 200 stores for the back-to-school season, those comp increases are off the charts.

So it's really early to state anything about kids, other than what we just stated in the call.

All right, thanks.

I know you said that accessories remained under pressure.

Can you just quantify that?

Yes.

So accessories, if you remember on the last call, what we did, is we said that we were trying to right-size the inventory.

So there were several things that we really wanted to do in the accessory business.

We wanted to right-size the inventory.

We wanted to aggressively go after key items.

And what we did is, we pulled the handbag business back, as you know has been under tremendous industry pressure for a lot of different reasons.

I was happy that in that pullback, even though the comp was not -- was disappointing, we actually delivered more gross margin dollars than we did last year.

So it was a more profitable business for us.

Do I think the accessory business going forward is going to change much?

I think that it's still going to remain under pressure, because of the handbag piece.

But the pieces that are really working well for us, things like casual hosiery which is our strongest [genre] that we've got going in the handbag and accessory area, that's on solid performance, and doesn't look like that's going to change at all.

And then, as I said in the call, we're trying to leverage the giftable and small leather goods businesses, more as an attachment business to those customers that may only walk out with one pair of shoes, and give them a reason why they should pick up one of those impulse giftable items.

All right.

Thanks very much for the color.

Good luck in the back half.

You're welcome.

Camilo Lyon, Canaccord Genuity.

Thank you.

Good morning, everyone.

Good morning.

Would you care to break down the components of the comp?

Traffic, ticket, ASPs, UPTs, that information would be helpful.

Sure, this is Jared.

What I'd say is our transactions were up in the low single-digits.

So we saw a good response from promotions and the advertising we were doing there.

From a basket or an ADS standpoint, we saw continued pressure on our AUR.

Again, a lot of that driven by some of the promotional activity, so that was down in the low single-digits.

And our UPT also was down in the low single-digits.

Okay.

And then, just thinking about some of the commentary that you laid out for the back half, the expectations around being less promotional, and having less markdown product.

In the context of the data you just provided, how do you balance, seeing positive traffic when you promote, going into a scenario or an environment in the back half, where you plan on being less promotional, but could conceivably have traffic fall off as a result?

How do you think about trying to work both of those metrics within your model, so that you have profitable traffic and profitable comp growth?

Yes, I think probably the best way to describe what it is we are doing, is we're not promoting in the conventional way think you see retailers do, where it's some percent off, those types of things.

What we're doing is taking stories that are embedded within our assortment, and screening them to the customer.

So we had an incredible event, a $29.95 sandal event, and we didn't have to take markdowns.

It was what our assortment looked like.

All we did was package that in a way that the consumer could see, we had a compelling offering at a killer price point.

We had the same kind of experience we're going to play out in the fall season, whether that be in boots or other areas of the business, rather than screaming 30% off the store, which frankly, is what we did last year because we had excess inventory.

So what we're wanting to do, is what we've historically built this business on, is leverage the assortment that we buy, our merchants buy, day in and day out, and tell that story more effectively to the customer.

That's the approach we're taking in the back half.

And then, how does that impact your AUR outlook?

AUR, obviously, if you're not running some percent off, should be higher in the back half than what it was last year.

Okay, got it.

Good luck in the back half.

Thank you.

Yes, thank you.

Scott Krasik, Buckingham Research Group.

Yes, hi, everyone, thanks.

Maybe just to start off bigger picture, Debbie, can you just talk about how this comes around to being a positive comp story again?

Kids hopefully should be a driver of that.

So does that expand in spring, and just what's your outlook for that?

Thanks.

So I guess what I heard you ask, Scott, is how do I think about returning to flat to positive comps in the back half?

Not for the back half, sorry.

I mean, in longer term.

How do we get back to being a positive comp story?

Okay.

All right.

So there is two big things that I think we're really focusing on, that should give us significant growth to drive those comps.

The first thing is our kids launch.

As you know, we launched over 200 stores for back-to-school.

In March we'll pulse out another approximately 89 to 90 stores.

And in July, we will do the balance of the chain.

So we're looking for significant growth there obviously.

That's a pure plus for us.

And that not only adds kid's growth, but it potentially adds adult footwear growth.

Because when those moms have their kids, they actually leave our brand, and have to go somewhere else to buy children's shoes.

And then they may also pick up an adult footwear purchase somewhere else.

So we believe that there is some incremental business there as well.

Number two, the whole athletic and athleisure business is continuing to show strong traction.

It's not slowing down at all.

And what I'm really excited about is, in the women's non-athletic brands, Scott, what we're seeing is this whole influence of sport, sport fashion vulcanized.

It's actually popping up in the women's fashion brands, and that's a pure plus from last year.

So I look at that whole business, athletic and athleisure as continuing on the same momentum, and the trajectory and growth not slowing down at all.

So those are really the two places that I think we have the biggest opportunity.

But I just want to go back to something that Roger just talked about.

How are we really going to get these messages out to our customer?

The kind of product that we buy, there are many stories that we're able to tell with that product.

And we're getting a lot smarter, and a lot sharper in packaging these stories, and telling that story to the customer, so that it really makes sense to them.

So it's not just a huge assortment of things that they have to buy.

In addition to that, what we're doing is we're adding, really pulsing every single month, these terrific value buys that we're buying from the market, in some key national brands, and we're pulsing these stories constantly, every single month, to tell the customer about the great brands we have, the products we have, and the great values that we offer.

And I think that over time, the customer is going to learn that they need to come back to us consistently, and on a more frequent basis.

So those will be the three things that I would tell you are significantly differentiated from last year, that I think will help get us back to flat to positive comps.

Debbie, that's (multiple speakers) -- oh, sorry.

That's okay, Scott.

This is Roger.

I will -- I'll add some additional color too, if that's okay.

I think the other big opportunity we have, and we mentioned it in the call, is that the more product we can put in front of our consumer, in a warehouse that opens its doors every single day to the customer, the more effectively we can serve that customer.

So an example, we have tested athletic in some of these stores.

We've called it a sneaker shop, in a bigger way, so putting more choices on the floor.

And guess what?

Like I said on the call, they buy more athletic.

What we've got to do is to find ways to present that product differently in the store, without having to pull other goods off the floor.

And when we do that, we see that it drives comps.

And so, those are -- that's an example of when we talk about opening the doors to our warehouses every day.

That's a big differentiator for us.

So I think that's another piece that we're going to go after, in finding additional categories that we can place into our stores.

That leads to my next question.

So you mentioned the digital demand increased 21%.

You've been hesitant to really talk about that in, with prior management.

So maybe help us understand, what does a 21% increase in digital demand really mean?

And how are you winning versus the internet pure plays, because we get that question a lot?

Yes.

So I think for us, where we're really growing in the digital space, like everyone else, is in the mobile space.

And that we have some things we're doing with our site that we're going to launch later this year or early next year, that we think will add huge value.

I will tell you the big thing for us, is just leveraging the assortment that we have today, and telling those stories in a more compelling way to our customer.

And what we see is, by having our warehouses be within 20 minutes of our customer, they love to engage both on the website as well as in the store.

And we used to always call that omni, it's not omni, it's just retail.

That's the way we're operating.

We think of ourselves, when you talk to our digital team about how we play, they think of themselves as a pure play.

It just so happens the warehouses that we're using to fulfill the demand that they're creating in the digital space, happen to have our sales associates that are there to service our customer, to do buy online pick up, buy online ship-to-store, whatever that might be.

So we're growing digital by leveraging the tools that we have built over the past few years.

And how big is digital as a percent of total?

We don't get into that detail, but it's growing at a rate that is faster than everything we see out there in the overall market.

And it has been for the past five or six years.

Okay.

Good perspective.

Thanks so much.

You're welcome.

David Mann, Johnson Rice.

Yes, thank you.

Good morning.

Just question on the kids effect on the business.

Can you talk a little bit about what you're seeing in the stores that don't have kids, versus the ones that do have kids?

Any kind of magnitude of difference in performance?

David, this is Roger.

I, unfortunately, right now, it's just too early for us to get into that kind of detail.

I think, as we get through the third quarter and sell-through the back-to-school assortment that we had, we're more than happy to share some of the results.

But right now, I would tell you it's just too early.

It is achieving the expectations that we had set out, out of the gate.

That's how we're measuring it.

It is --

And then --

It reassured us, that it is something we want to move forward through the balance of the chain.

And as we think about the comp expectation for the back half, given the kids tailwind in Q3, should we expect a disparity between Q3 and Q4 comps, and potentially positive comps in Q3?

David, we don't get into that kind of detail.

I will just tell you, I think, over the back half we're in the low single-digit negative comp, is the place in which we're targeting.

All right.

And then, you talked about activating some inactive customers.

Can you just give a little more detail on what you're achieving there, in terms of your loyalty membership, the growth in general, and the growth in active customers perhaps?

The, what I would tell you in general, the ROI that we're generating off of these inactive customers is exceeding our hurdle rate.

So we're happy with the success we're having there.

Also, our retention rate that we have within our rewards program right now is at an all-time high.

So we're going after people that have not shopped us in a 12 month or longer period of time, and reactivating them into the brand.

So it's achieving our hurdle rates.

And while it's not at the margin rates that we generate off of just a standard rewards member, it is bringing that customer back into our experience.

So just to clarify, you're giving them an extra discount to come back?

I mean, going back to I think an earlier question about sort of trying to retain that customer, do you feel like you're going to need to continue to give them a teaser discount to keep them active?

No.

What we have seen is that, that is a way to get them back, engaged with the brand.

But then, by focusing our messages around what's embedded in our assortment, screaming the value proposition we have within different offers that Debbie and team are bringing to the table, that once we get them back, we can retain them without having to offer additional discounts.

Thank you.

Good luck in the back half.

Thank you.

Jeff Van Sinderen, B. Riley.

Good morning.

I wonder if you could just update us on where you stand on price matching?

And then, how and when do you think the IMU begins to increase?

Your guidance seems to reflect that trend toward lower discounting year-over-year for second half.

But I'm just wondering how much of that is largely due to leaner inventory controls?

And then, also if you could speak to what you are seeing, in terms of new store performance?

And then, would you expect to continue growing the store base at a similar pace in 2017?

Debbie, you want to take the first half, I'll take the second half?

Sure.

So in terms of pricing, in the back half, by planning a more realistic comp in the back half, and matching the inventory for that, I am not anticipating that we are going to have inventory issues.

We're really planning the inventories very tight.

In terms of our pricing, I think what we're doing is, when you have leaner inventories and you're not having to promote your way out of inventories, and you're buying compelling buys at the right price, that is allowing us to hit our AUTs and AURs that are built into the financial plan.

So we're going to do it more by buying the right merchandise, buying into it correctly, at the right cost, and retailing it where we think we can sell it, versus having to discount and coupon at the back half, which really lowers the AUR.

On the new store performance, Jeff, we are achieving our hurdle rates on our new stores that we've opened in the back half of last year, as well as the front end of 2016.

As far as future store growth, we believe in stores.

We believe in a combination of stores and digital to provide an experience for our customer that is differentiated.

Again, I keep saying this, but we are excited by the fact that we open the doors to our warehouses every single day, and we're going to place warehouses as close to our customer as we possibly can to service them.

It provides us, not just sales within that market through brick-and-mortar, but also grows our digital presence, every time we open that billboard in that local market.

So you're going to see that the growth will not be the 40 store growth that we have been experiencing.

It will be a slowed growth, but it will be growth in store count.

Okay.

That's helpful.

Thanks, and good luck for the rest of the quarter.

Thank you.

Patrick McKeever, MKM Partners.

Okay, thanks.

Good morning, everyone.

A question on just pricing versus the department stores.

It's a common topic, a topic that comes up a fair bit, just wondering where you feel you stand?

I know there's been an effort to sharpen up on some of the items that are most comparable to the department stores, and wondering how you feel about that right now?

And then, the second question is, just on the financial impact of the partnership with the Apparel Group in the Middle East.

How will that flow through the P&L?

Will there be a separate line item there?

Just something like income from a franchise partner, or how will that work?

Okay.

Good morning, Patrick.

This is Debbie.

Good morning, Debbie.

I'll take the first part of your question.

Thank you.

So the way I think about pricing is, I really look at our entire value proposition within DSW.

And there's a piece of the assortment, obviously that is core key items, and we plan on continuing to build those core and key items as must-have items for the season.

By increasing the depth of those buys, we will, we look to get better costing on those and better sell-throughs obviously.

And so, there is a -- there should be a plus margin positive margin implication there.

The rest of the value proposition really falls under three buckets, and I think of closeouts really more as opportunity buys.

So what are those deals that we can buy consistently throughout the season, as we work very closely with our vendor partners, to buy the right product, and offer some really great, great values to our consumer.

I don't think about that so much relative to department stores, as I think about getting your hands on the right product, and putting some real sharp values on those, that deliver the financial metrics that we need to deliver for the business.

The next piece of that would really be deals that we actually package within the assortment that we've already bought that, that we pulse out to the customer in those monthly stories, that allows them to rely on the fact that they can come to DSW every single day, and find a really great opportunity.

So there are close-outs, increasing close-outs and opportunity buys.

There are special deals that we buy.

And then, there's also the exclusives.

And exclusives are a terrific benefit to DSW, in that these are products that are designed and engineered specifically for DSW.

They are the right items, great value.

And part of that value comes from our private brand, but also comes from great leverage in buying the items bigger.

So that we can pass more value on to the consumer, while at the same time hitting the financial metrics that are required in our business.

So when I -- I really don't think about how are we going to play defense around department stores, I think of it more as offense.

This is what DSW offers, and we do offer the best brands, the best products, at great value to the consumer every day.

And that's a great reliability for the customer, that they don't have to guess where to go, at what time.

They know what to expect from DSW, and we exceed their expectations every day.

And Patrick, this is Jared, regarding the Apparel Group contract.

Obviously, it's still very new, and so, we have not formally established the accounting position on that.

What I will say is, what we believe will be the case.

There's multiple revenue streams from this agreement.

The largest obviously, would be more of a royalty type of income.

It looks like that would be counted or accounted for as net revenue.

So flow through a net sales line with very little cost, so kind of flow down into margin that way.

Okay.

Very helpful, thanks.

Kate McShane, Citi Research.

Good morning.

Thanks for taking my question.

If I could just follow up on the last question, with regards to the competitive landscape, and just inventory levels, where it does appear that a lot of your competitors are carrying significantly less inventory this fall season.

I know you highlighted the ability to chase, but where do you think you are positioned from an inventory availability standpoint versus your competition?

And up to what comp are you able to chase in the fall?

Sure.

So good morning, Kate.

So I will tell you on the key items on the core items, we actually protect ourselves.

We buy the big items the, with a unit buy plan that we align on with planning.

So we really know where the big dollars are coming from and the big items, but how do we protect ourselves?

We do backups with our key vendor partners.

And I call them [cancelable] backups, but what I would like to really say is they're negotiated backups.

So in other words, if we need the products, they are there in the pipeline for us to bring into our inventories.

And if we don't need them, that we react with the vendor and the vendor partnerships that we have, in the time that we can trade things out, so that you don't really hang the vendor with something that they don't want.

So that means that you have to work much more closely in the supply chain, the front end, the back end of supply chain.

So that's how we protect our key items.

In terms of opportunity buys, a little over a year ago, we put in what we call a pre-buy bucket, which allows you to do a couple of things.

Number one, it allows you to buy great opportunities at the end of the season, and hold them until the next season, when it's timely to allocate them.

In many cases, what that does is, that positions you to capitalize on say, for example, we bought sandals at the end of July.

We bought close-outs for the end of July, and plan to release them in 2017.

If the season extends itself, gives you the opportunity to pull those into the inventory, maximize the season.

Or wait and allocate them when you originally intended for them to go into the stores.

The third piece is, we're in the market every single day.

We don't buy [store] sets like many of the other retailers do.

So we're in the market every single day, chasing into those things that are good for us, and looking for opportunity buys.

So I've really never encountered a season where there wasn't merchandise out there to buy.

I want to make sure that I get the bigger piece, the bigger percentage right up front, and we do that.

And like I said, we work with our vendor partners to protect us on the big must-have key items.

And then, I think it's smart and wise to have open-to-buy liquidity, and chase into things as customers start to vote.

And in that way, you're not left hanging with inventory that they don't want.

It's goods that they've told you they want, and your vendor partners have partnered with you to get you what you need.

Okay.

That's very helpful.

Thank you.

And my one unrelated question, second question, is just I think there was some commentary in the prepared comments about the capital budget, and some pull back on store renovations and technology investment.

Do you have any more color into that, please?

This is Jared.

What I would say is, we took the opportunity with our expense initiative to look at all dollars going out of the business, that included capital dollars.

And one of the things that we found was that demand management on, when we -- when a store might call in, and ask for a carpet refresh or something like that, demand management is an area we've got lots of improvement in.

And we think that there is an opportunity there to be a little more judicious with the dollars going out, and not necessarily having to respond with 100% kind of SWAT team with every type of request.

So that's a big piece of where that's coming from.

Kate, I would tell you, I think the other opportunity we have is, in the past three years we have invested a lot in our IT space for tools and technology.

And as a team, as we step back and look at how effectively we're using the tools that have been built, we're not optimizing the things that have been built.

And so, as an organization, we keep talking about focus, focus, focus.

Let's leverage the things that have been built.

Let's see that they're driving the kind of value that we wanted, before we start moving on to building the next thing.

So whether that be in the omni space, whether that be in the digital space, there are some things there, where we know we can be more effective with the tools we've already built, before we start marching toward what's next.

So that's a big chunk of what was that pullback in capital.

Thank you.

You're welcome.

Steve Marotta, CL King & Associates.

Steve Marotta^ Good morning, everybody.

Given the low single-digit negative comp that's expected in the back half of the year, what do you expect children's to be quantified vis-a-vis that comp?

In other words, what do you think that contribution will be, to the negative low single-digit comp in the back half of the year?

I'm sorry, Steve, you cut out in the middle of that question.

I couldn't, are you asking how much would be digital versus store?

Is that what?

No, children's.

(multiple speakers).

What is the children's contribution to comp embedded in your guidance for the back half of the year?

Yes, we -- Steve, we don't get into that detail.

We'll tell you again, out of the gate, we're happy with the results we have seen, but we don't want to share that kind of information at this point.

Can't blame a guy for trying though (laughter).

If you said this on the call, I'm sorry that I missed it, could you talk about what the merchandise margin delta was in the second quarter?

For the second quarter, merch margin was down in the low single-digits, driven primarily with a decrease in IMU.

But a big piece of the IMU was related to Ebuys operating at a very different model than ours does.

So organic or anything not Ebuys was much more modest, but merch margin came in, in the low single-digits.

Okay.

Lastly, can you comment on the small format stores, and how they performed in the quarter, and where you see that going forward?

Yes.

So Steve, we mentioned this last quarter too, that we're actually, we're happy with the results we're getting.

What we want to do is to build an experience in those stores, that can display the breadth of assortment that Designer Shoe Warehouse offers to the customer.

And we're working to solve that through some new fixturing and other things.

The piece of data that I'm really excited about is that, our team shared with us yesterday some of the results of -- we call it [charts in].

But the ability for those stores to act as a fulfillment center in that local market.

And we're seeing double-digit percents of their total sales coming from digital demand meaning -- and orders being placed in that small market, and it's being fulfilled by that store.

So again, it's just one more reason why we believe there is something there.

We're going to continue to work on it, until we can nail it, and it actually either looks like Designer Shoe Warehouse in a small market, or it's got a different banner, or whatever it might be.

There is an opportunity for us to be in those markets.

We've got to figure it out, and we're working on that.

Terrific.

Thank you very much.

You're welcome.

Kelly Chen, Telsey Advisory Group.

Hey, guys, nice job, and thanks for taking my question.

My first question is just on the cost savings, the $25 million.

Can you give us a little bit more color or examples on how and where you're cutting costs?

And then in terms of the timing, for the component that's coming in 2017, do you expect most of that to come in the beginning of 2017, or is that a gradual process?

And at this point, are you planning on reinvesting any of that savings, or should we expect most of that $25 million to drop to the bottom line?

Hi, Kelly.

The breakout of the $25 million really was across three different kind of buckets I would call it.

So we had reorganizational alignments, where we looked across the business and tried to find where there were opportunities to increase efficiency in the way we work.

So we're seeing roughly around half of that $25 million coming from that organizational realignment.

The other two buckets, about evenly split are amongst how we buy things, non-merchandise for resale items, but services and products that we use here and in our stores.

Buying that better and more strategically, trying to leverage scale, trying to make sure that we are always bidding things out in a strategic way.

So, better buying.

And then some infrastructure changes that either just are changing, because we've evolved the model, or we are looking at how we operate certain parts of the business.

So amongst that, it's kind of how we break it out.

From a timing standpoint, we aren't prepared to talk about 2017 at this point.

What I would say is, it's probably going to come across pretty evenly, again given half of it was organizational realignment.

That's a pretty even across the year save.

So again, we're not ready to talk about 2017's guidance, but I think it's fair to say, it should be relatively even across there.

Was there a last -- oh, and then to answer your question about, are we reinvesting the $25 million?

Right now again, we are not commenting on 2017, but I think you'll see the vast bulk of this materialize in SG&A savings in 2017, not looking for reinvestment.

Great.

Thank you.

And then just a quick follow up, Debbie, you talked a little bit about the boot business, and what you're expecting for the back half.

But could you talk more broadly about what fashion trends you're most excited about for the fall?

Yes.

So good morning, Kelly.

So the back half as I said, we're going to be very conservative in our approach.

You're going to see a bigger shift between booties -- into booties and out of boots.

We see some real excitement in that category.

It's about a 70/30 split between booties and boots.

We're seeing some nice early reads right now, too early to call the game.

We're only -- not even a week into fall yet, if you really look at what the weather looks like out there.

But the trends that we see right now, things that are really driving the business, and we're already reordering are peep-toe [shooties].

So anything that's on a bit of a heel, anything that's opened up, the sides opened up, the toes opened up, are resonating very, very well with the customer.

And I think that we -- we're going to have a few more months of what that looks like.

The other kind of booties are very, very different from last year, in terms of the detailing.

The colorations are big, the materials, lots of suede this year versus leather last year.

Although we must make sure we have a balance between suede and leather.

So I see freshness in the booties this year.

Some of those booties are already starting to resonate, even the closed-up booties.

But once again, it's real early in the game to call that.

The biggest thing happening in tall boots, the biggest shift I see in the business is the riding and the sports boot really down trending, and over-the-knee boots, what few there are out there right now, the customer is voting very strongly on.

So I'm excited about what I see going forward.

I'm getting some nice indications that it should be a decent season.

But once again, we're a week into it, so I don't want to get too overexcited.

Great.

Thank you.

You're welcome.

And due to time constraints, the last question will come from Jay Sole of Morgan Stanley.

Great.

Thank you so much for taking my question.

My question is on inventory.

Some brands out there are saying their sell-through is good, but their reorders are not so good.

And I know you said conceptually, you planned tight.

Is there any kind of imbalance in the inventory, where some of the strong brands are in really good inventory positions, but maybe some other brands that aren't selling as well, are stuck?

And you just feel like you want to get everything down to a certain level, before you can really start to re-buy at a different rate?

Is that at all what's going on?

No.

I don't really think about it like that.

The way I think about it is, when I break the business up into -- like I said a little bit earlier, chunks of the business I think about what are the key core must-have items of the season, and are we buying them big enough?

Are we sitting with our vendor partners and our planning partners to actually project those numbers out appropriately?

And are we putting the right backups in place to be able to support the level of sales, that we believe the customer is going to vote on?

And if it doesn't materialize like that, are we working with our vendor partners to try to make sure that we move things around?

Or you may move the material to another kind of a boot, if a particular boot isn't selling.

So I really -- I think it's all in terms of how you plan your business.

I am not seeing huge imbalances right now.

We see a lot of close-out lift.

We see a lot of opportunity buy lift.

But I'm not really seeing any big imbalances right now, because I think we've planned conservatively.

We were very deliberate about what we believed in, and we bought it like that.

And then, I think the big thing is always make sure you are in a testing mode, because the customer is changing their mind so quickly about what they want, and fashion comping much, much higher right now than the traditional classic piece of the business.

You always have to be testing and reacting, and making sure you know what's new and fresh.

And you have to be in a liquid position to be able to do that.

So right now, and it's early in the season, I'm not seeing any imbalances right now.

Will that happen as we get further into the season?

That's the nature of the business.

But I'm comfortable with how we've planned the business on the back half right now.

Okay, that's really interesting, if I can ask one more.

On the athletic side, is it -- the comps continue to be very strong.

Is it one brand driving, is it many brands, have any new brands emerged that are really helping that athletic comp?

So I will tell you that the strongest -- both men's and women's are comping strong double-digits.

And there's a little bit of a gap there in terms of the comp, but it's pretty consistent between the two genders.

Fashion is driving everything.

So both fashion and performance are comping positive, but fashion is really comping positive.

So without calling out names of brands on the call, when you think about the vulcanized business driving over half of the fashion sales, you can kind of guess what brands those are -- anything in vulcanized.

So the big brands that are in the vulc business, doing very well.

But most anybody that's jumping into the right vulcanized item is actually enjoying a nice sell-through.

So we're really doing it with our key athletic brands.

The key vendors that we've always done business with.

They've just gotten stronger and stronger.

What I talked about earlier was I'm really happy that the women's and the men's non-athletic brand -- so the black and brown brands have really jumped into this sport and this athleisure trend.

And they're starting to come to the table with some really exciting things.

And that's where we are seeing very, very large comps come from.

Got it.

Thank you so much.

And so, thanks everyone for your interest and support of DSW, and we look forward to reporting progress on the third quarter earnings call.

Thank you.

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