Designer Brands Inc (DBI) 2018 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Thank you for standing by.

(Operator Instructions)

As a reminder, today's conference is being recorded.

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

Ms. Cheng, please go ahead.

Good morning, and welcome to DSW's Second Quarter 2018 Conference Call.

Earlier today, we issued a press release comparing the results of operations for the 13-week periods ending August 4, 2018 and July 29, 2017.

Comparable sales are calculated for the same 13-week periods ending August 4, 2018 and August 5, 2017.

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

Results may differ materially due to various factors listed in today's press release and in our public filings with the SEC, and we assume no obligation to update any forward-looking statements.

Joining us today are Roger Rawlins, Chief Executive Officer, and Jared Poff, Chief Financial Officer.

Now let me turn the call over to Roger.

Thanks, Christina, and good morning.

We're pleased to report one of the strongest quarters in our history, with a 10% comp, healthy margin expansion and 68% earnings growth from ongoing operations.

On a rolling 12-month basis, these operations delivered a 3% comp and 31% earnings burn.

As we laid out our strategy for fiscal 2018, we decided to return to playing offense by investing in talent, inventory and marketing.

The incredible results this quarter, the best comp we've had since 2011 demonstrate the power of playing to our strengths.

The launch of our rewards program along with investments in digital marketing resulted in traffic increases in both our warehouses and online.

From a merchandising perspective, we distorted inventory to sandals, athleisure and kids footwear, which drove a significant portion of our sales increase.

Every category in the U.S. retail segment, women's, men's, athletic and accessories, had positive comps in Q2.

We're committed to fueling this incredible momentum going forward with the right investments, and consequently, we've raised our sales and earnings outlook for 2018.

We consolidated our Canadian acquisition for the first time this quarter.

We've chosen to exit our smallest Canadian banner in order to focus on the businesses that can best leverage our core competencies and provide us a strong foundation to grow our business in North America.

Let me turn the call to Jared to provide more details of our financial performance, update guidance and our long-term plans in Canada.

Thanks, Roger, and good morning, everyone.

Let me echo Roger and say how pleased we are to report one of the strongest quarters in DSW's history.

Total company revenues increased by 16% to $795 million this quarter, with a 10% comp in our core business driving operating margin expansion, net income and EPS growth.

Let me turn briefly to our Canadian acquisition.

After investing in a minority stake in 2014, we completed the purchase of the remaining interest this past May and assumed full control this quarter.

Shoe Company and Shoe Warehouse, 2 family footwear banners, account for the lion's share of the business, operating 113 locations averaging 5,500 square feet.

DSW Designer Shoe Warehouse comes next and currently operates 27 locations averaging 19,000 square feet.

Collectively, these 3 banners account for 85% of the sales.

The smaller banner, Town Shoes, is a full service, mall-based, mid-luxury retailer with 38 locations averaging 2,500 square feet.

We appointed Bill Jordan, a DSW leadership team veteran, to head up our Canadian operation, and he has completed an evaluation of the entire business over the last 90 days.

After taking into account the historical performance, competitive positioning and future requirements of each business, we have decided to focus our efforts on the Shoe Company, Shoe Warehouse, DSW Canada banners, which serve as a target demographic similar to our U.S. retail business.

The decision to exit the Town banner was a difficult decision to make given its heritage.

Unfortunately, as the competitive landscape for mid-luxury, mall-based retail dramatically changed, comps have deteriorated consistently and pushed operating losses to close to $10 million annually.

Over the last few years, the team undertook several actions to shore up this business but was unsuccessful, given its long-term lease obligations and high-operating-cost model.

We struggled to see a path that returns the Town banner to either growth or profitability in the foreseeable future, and as such, we've made the decision to exit the Town Shoes banner.

We -- this will eliminate future losses and allow us to apply our management focus on the 3 go-forward banners closest to our core business.

We have begun the process of reaching out to impacted associates and expect to have nearly all of the operation shut down by the end of the fiscal year.

We recorded several Q2 GAAP charges as a result of this integration that are excluded from adjusted results.

First, as part of a 2-step acquisition process dating back in 2014, we reassessed the fair value of previously held assets, including our equity investment and note receivables, which resulted in a charge of $34 million.

Next, based on our long-term projections and our decision to exit the Town Shoes banner, we recorded a goodwill impairment charge of $36 million to reflect lower fair value of its acquired net asset.

And finally, we flowed $13 million of foreign exchange losses mostly related to the reversal of accumulated other comprehensive income, which was previously recorded on the balance sheet.

We also incurred $5 million in acquisition-related transaction costs this quarter.

For a complete reconciliation of our GAAP to adjusted results, please refer to the non-GAAP summary table in our press release issued this morning.

As a result of the acquisition, we introduced 2 reportable segments: the U.S. Retail segment, which was previously presented as the DSW segment, and the Canadian Retail segment for our new subsidiary, which will maintain its headquarters in Toronto.

Our priorities this year are to align the DSW Canada banner closer with our U.S. business and strengthen inventory disciplines and merchandising processes.

We've made significant headway in reducing aged inventory levels this quarter, which previously constrained the full-priced assortment.

Furthermore, we're targeting operational enhancements that will improve service levels and deliver a more consistent brand experience.

Long term, we've identified 3 key opportunities for our Canadian Retail business.

First, with online demand penetration currently running below the national benchmark, we're focused on accelerating online growth.

We're drawing our -- on our substantial expertise in online retailing to fully exploit the boom in digital demand that Canada, as a country, is just beginning to recognize.

To do this, we will re-platform our fast-growing e-commerce site next year, which will create a better mobile experience, integrate our loyalty program and enable Drop Ship capabilities.

Secondly, DSW Canada has healthy prospects for continued store growth, with potentially a fleet of up to 40 to 50 locations over time.

Our Shoe Company and Shoe Warehouse banners, which also have modest expansion potential are well positioned to gain share from competitor store closings in the moderate-priced channel, and we will continue to optimize real estate over time to improve their solid economics.

And third, we have a significant degree of vendor overlap between our Canadian and U.S. Retail operations.

We expect to improve sourcing costs as we leverage the size of DSW's stencil, and we have kicked off a study to identify efficiencies across our North American supply chain.

We expect the go-forward business to be slightly accretive this year and generate a low single-digit operating margin rate.

Under new leadership, process improvements and the exit of the Town Shoes banner, we believe our Canadian business has a potential to earn up to $10 million to $15 million annually in operating profit over time.

That said, let's bring our discussion back to our second quarter financial results.

The rest of our commentary below refers to adjusted results.

Second quarter revenues increased by 16% to $795 million this quarter, including $73 million from the consolidation of our Canadian Retail segment.

On an organic basis, excluding the acquisition and business exit, total sales increased 10% driven by a 10% increase in comparable sales, our strongest comp in 7 years.

This quarter's comp brings us to a 6% comp increase for the spring season.

The strong profitability improvement this quarter resulted in adjusted earnings of $0.63 per share.

This includes a loss of $0.01 per share from the operating results of the Town banner, which we expect to exit by the end of this year.

Sales at our largest business, Designer Shoe Warehouse, increased by 10%, driven by a 10% growth in comparable sales.

All categories posted positive comp growth for the first time since first quarter of 2015.

The VIP program launch and digital marketing investments drove traffic, and we are pleased with an increase in average spend per customer and new customer activity.

Our better in-stock position drove a higher mix of regular-priced sales and better margins, while our open-to-buy liquidity enabled us to aggressively chase this upside.

Our omnichannel investments paid off, as our cross-channel strategy resulted in some of the strongest digital growth rates in the industry and a double-digit increase in transaction activity driven by all channels.

Our footwear category exceeded our expectations, with a 10% comp increase, the fifth quarter in a row of positive comp.

Our sandal distortion fed the robust customer demand for seasonal footwear and drove healthy double-digit comp gains.

While consumer appetite for the athletic lifestyle remains healthy, demand for nonathletic footwear improved across dress, casual and seasonal offerings.

New styles in fashion sport are reenergizing the athleisure category, and we are excited with the new opportunities to grow our core athletic offering over time.

Men's footwear, including athletic, turned positive this quarter, and we continue to focus on introducing fresh taste on dress and casual comfort.

After turning the corner during the first quarter, the accessories category delivered a positive comp this quarter.

Under our new GMM, we have reset this category's breadth and depth; introduced new complementary product lines; aligned our good, better, best assortment; and expanded our digital presence online.

We're also starting to expand accessories for kids, starting with backpacks and athletic socks, for the back-to-school season.

We completed the fourth and last phase of our Kids rollout this quarter, with 94 new locations finally bringing DSW Kids chainwide this year.

The Kids business makes us more competitive during the important back-to-school season, which has traditionally been a valley in our sales curve.

We have lined up our buys to support this business as it gains more traction from a national marketing campaign and increasing customer awareness.

Part of the labor investment we've made this quarter includes dedicated fit associates who are trained to specifically serve the needs of young families.

With Kids accounting for 10% of the footwear market, kids’ footwear will become an important driver of sales productivity long term.

We're learning more about the Kids opportunity from our Canadian business, where the Kids business has a significantly higher penetration than the U.S.

Turning to our other business segment, which reported total sales of $29 million compared to $52 million last year, with the exit of Ebuys and Gordmans driving the decline.

Our ABG business continues the momentum from last holiday and posted a 12% comp increase this quarter on lower inventory.

We continue to be encouraged with the response to our marketing and merchandising initiatives with Stein Mart.

The ABG business ended the quarter with 289 locations.

Lastly, our Canadian -- our Canada Retail segment beat its sales plan and posted positive comps across all banners.

Although some of this comp was achieved by clearance activities, especially in the Town banner, we are encouraged with top line results that delivered profits in line with our expectations.

We ended the quarter with 178 locations and expect to close the majority of the 38 Town Shoes banner's by the end of the fiscal year.

Turning to gross profit, the company gross profit as a percentage of sales increased 280 basis points, driven by business mix and improvements in the DSW segment.

On the organic basis, DSW and ABG segment gross margin improved by 230 basis points, largely driven by lower clearance markdowns, favorable sourcing costs and occupancy leverage at the DSW segment.

With our inventory discipline, improved sell-throughs and vendor accountability, we are committed to drive gross margin improvement on a sustainable basis.

Q2 SG&A increased by 23% and as a percentage of sales, the SG&A rate increased by 130 basis points.

The consolidation of our Canadian subsidiary accounted for approximately half of this dollar increase, and planned investments in marketing at the DSW segment drove the balance.

As a result of strong execution this quarter, our gross profit improvement more than offset expense deleverage this quarter.

Operating profits increased by 40%, leading to a 150-basis-point expansion in operating margins.

With the consolidation of our Canadian subsidiary, we ceased reporting income from equity investments starting this quarter.

Finally, second quarter adjusted income tax rate decreased from 39% last year to 27% this year, primarily due to the implementation of tax reform.

Turning to the balance sheet, as we prepare for the key back-to-school selling season, we are targeting a higher level of productive inventories to support our key merchandise initiatives.

Excluding inventory from our Canadian Retail and exited businesses last year, inventory on a per square foot basis was 12% above last year, with Kids accounting for 1/3 of that increase.

On a 2-year basis, inventory per square foot increased by 2%.

As we rebuild our inventory capacity from historical lows, we expect our inventories to remain above last year, as higher receipts arise ahead of the key holiday selling period.

Nevertheless, we will continue to plan greater open-to-buy liquidity to react closer to need.

We ended the quarter with $289 million in cash and cash investments, a 7% increase to last year's $271 million.

Quarter-end cash reflects the $35 million paid for the acquisition of the remaining stake in Town shoes.

Our strong capital position enables us to invest in our core business while strategically acquiring assets that can leverage our expertise and expand our customer base.

We spent $15 million in capital expenditures this quarter, including $2 million for our Canadian Retail operations.

Full year CapEx is expected to be $90 million this year, including incremental CapEx from our Canadian acquisition.

We are on budget with our CapEx spend, which is primarily driven by store maintenance, DSW Kids and our new-store design pilot.

We ended the quarter with 517 warehouses in the U.S. and plan to open 3 to 6 net new locations this year.

Turning to our outlook for 2018.

Based on the momentum this spring season, we're raising our comp and EPS expectations for the balance of fiscal 2018.

We now expect full year comps to increase in the low to mid-single digit range and expect total revenues to grow in the 6% to 9% range and put us over $3 billion in top line revenues for the first time.

This assumes revenues from our new Canadian subsidiary of $215 million.

We've raised our full year outlook for adjusted EPS for our ongoing business to range from $1.60 to $1.75 per share compared to our previous outlook of $1.52 to $1.67 per share, including a slightly accretive impact from the ongoing Canadian business.

Given the degree of variability we face as we exit the Town banner, this excludes losses from the Town banner as a result of its ongoing operations through its final wind-down.

We will include this impact in our adjusted earnings, but we'll call it out separately as you model adjusted earnings from our ongoing businesses.

Excluding charges related to the acquisition and other GAAP adjustments, the midpoint of our earnings outlook implies a return to a low double-digit earnings growth for the first time since 2013.

We are on track to deliver strong growth year-over-year thanks to investments we've made over the last few years, renewed focus on buying and inventory management, and a stronger accountability for execution.

With that, let me turn the call over to Roger to share the progress we've made on our strategic priorities.

Thanks, Jared.

When we laid out our strategic initiatives for 2018, our objective was to increase market share in a consolidating retail environment.

I'm proud to report that our plan produced better-than-expected results this season.

By moving to an offensive mindset, we accelerated our top line and grew market share while delivering better-than-expected profitability.

We're on track with our strategic initiative, which will evolve our business model in a rapidly changing retail environment.

Now that we are halfway through 2018, I'd like to give you an update.

First, (inaudible).

Our focus on distorting inventory investments at seasonal, Athleisure and Kids drove substantial sales increases in the DSW segment.

These 3 areas accounted for 85% of our sales increase the last year in the second quarter.

Our focus on increasing key items across all categories is driving better in-stock, better conversion and stronger regular-priced selling.

As I mentioned earlier, all major categories had positive comps this quarter.

The addition of Kids is increasing customer lifetime value and acquiring new customers to the DSW brand.

In addition, we continue to elevate our products through exclusive or owned brands, which delivers far superior margins today and has the potential to achieve a significantly higher penetration.

Technology has made it easier for brands to develop a direct-to-consumer model and more than ever, it is critical we develop strong designs and sourcing capability either through continuing to build them internally or through an acquisition that can take our exclusive brands to the next level.

In doing so, we will drive more margin dollars and better margin rates for DSW Inc., give us more leverage with vendor who will have to compete for space in our warehouses against our DSW exclusive or owned brands, acquired additional expertise in footwear manufacturing that enables us to make better sourcing decisions, and potentially diversify our revenue stream through new channels of distribution that will enable us to become increasingly involved in a greater number of customer purchase decisions.

Owning these capabilities will enable us to differentiate our competitive offering while opening up new market opportunities long-term for our exclusive or owned brands.

Second, marketing.

We continue to substantially increase our investment in digital marketing.

We will continue to learn and refine our marketing investments to drive the most benefit possible.

We saw solid returns from our marketing investment, with growth in new customer transactions, average spend per member, rewards redemption and member activation rate.

Customer response to new perks, such as our new shoe-donation program, have been strong.

We're on track to donate close to 0.5 million pairs of shoes this year, demonstrating our ability to drive an emotional connection with our customers.

Third, people.

We rolled out our new operating model in the U.S. this quarter.

This model will create a better customer experience in 2 key ways.

Number one provides role clarity between our selling teams and our warehouse execution teams.

The selling team will be focused on customer engagement, while the warehouse team will focus on order and inventory management.

And it improves sales coverage and better aligns payable hours to traffic patterns.

Over time, we expect this new model to drive conversions and customer satisfaction.

Finally, innovation.

We continue to develop new service offerings that will differentiate our brand, our first W Nail Bar is delivering solid results, and we are opening our second Columbus location in the third quarter.

We are evaluating 5 potential locations outside the Columbus market for next year.

This expansion will provide great learnings on how to scale this service offering.

Shoe and handbag repair continues to perform well in our Columbus market, and we will be expanding the repair offering into our New York Metro market in Q3.

Last March, we rolled out a new fixture package to 4 stores, which significantly increases the choices and available inventory to customers.

Preliminary results are encouraging, and we will continue to make adjustments to learn from this new-store experience.

This new package has enabled us to introduce kids’ footwear in an important market without compromising adult capacity, turning one of these locations into one of our highest grossing Kids locations in the country.

We will continue to monitor these locations closely, as we continue to evolve our customer experience.

In summary, we had a tremendous second quarter and a first half of the year.

I want to thank our teams in the field and in the home office for their hard work.

The strategic initiatives we laid out at the beginning of the year are driving the core business.

We are confident our key investments will pay dividends and enable our largest business to generate strong cash flows to fund future growth initiatives.

We will remain committed to executing with a focus and tempo that creates long-term value and drive sustainable, profitable growth.

With that, let me turn the call over to our operator for Q&A.

(Operator Instructions) The first question today comes from Rick Patel with Needham & Company.

I was hoping you could provide a little bit more help with how to model the acquisition of your Canadian asset.

So first, as we think about sales, is there a seasonality that, that -- is the seasonality of that business comparable to DSW?

And is there anything to keep in mind as we think about the performance of stores versus e-commerce there?

And secondly, any color on how to think about Canada's gross margins and SG&A as we think about it from a mix perspective?

And also, as we consider the pathway to accretion for this year?

Rick, I'll start.

As you look at, sort of, the seasonality, actually, it's interesting.

This time of the year for us up in Canada is actually sort of our holiday window.

So it is different than what we've experienced here at DSW.

Simply because the Kids business is such a significant portion of the total business, as Jared had mentioned earlier, that is a big driver, the combination of Athleisure and Kids, in both Shoe Co and Shoe Warehouse.

So this August, early September kind of time period is a big deal for us.

And then obviously, the boot business up there is -- skews a little more heavily than what it does here in the U.S. So you'll see a little bit more in fall, you'll see some increase in third quarter versus what you have historically seen at DSW.

So those, I think, are the 2 big differences.

Yes, and from a modeling standpoint, I would say, we like our home segment, are not necessarily breaking out the gross margin and SG&A guidance.

But in general, from just a model standpoint, their business model operates at thinner margins and so right now, they want -- went to market as a smaller company.

We do hope to see improvements with the scale and the relationships we have with our vendors, benefit them.

So now I think there's improvement there over time.

I'm also much -- some of the Canadian footwear marketplace is still handled through distributors, which we don't have to deal with down here in the U.S. So that's not the bulk of their purchases, but it's still a piece in there.

And the SG&A rate, in general across all businesses up in Canada, tends to be higher than it is down here in the U.S. So that's why we have guided that they are expecting low, single-digit operating margins in total.

I would also say from a modeling standpoint, as I mentioned on the call, we are really looking at the opportunity to bring them more in line with, certainly, Canada and even with the U.S. from a digital perspective, and so you'll see kind of that transform over the next couple of years as we make the investments necessary to bring them into something more similar to what we experienced down here.

Rick, one thing I should've mentioned too is, I think one of the big learnings we've had here that has impacted our business in the U.S. is just how big the Kids business can be.

And with the success that Mary and the rest of our team up there've had with that piece of the business, it really did influence the kind of buys and direction we took here in the U.S. for our Kids business.

So we're really excited about the opportunity.

That's very helpful.

Can you also highlight the potential for synergies with DSW and the new Canada segment?

Now that it's fully owned, do you see the opportunity to reduce areas of redundancy and leverage, a bigger scale?

And on the flip side, where do you feel like investments need to be accelerated?

Sounds like digital is one area but curious if there are others.

I'm -- I would say, I think the biggest one is digital.

We were just sharing with the team up there the other day, we were having a strategy session, and when you take a look at what's happened up in Canada, it really does look like it's 3 to 4 years behind the progression of digital and how it influences the business here in the U.S. So given that all of us were here and went through that journey here in the U.S., we think there's a great opportunity for us to get really aggressive up there and grow in a digital way.

And also, as we'd mentioned on the call that there's still opportunity to grow doors, and I think that is a -- that's a great resource that the team here in the U.S. can bring because we've had a lot of experience, as you know, doing that.

And then the fact that the Shoe Co, Shoe Warehouse model plays in a much smaller box -- I would call it a more rural footprint than what we currently do -- it penetrates roughly 50% to Athleisure and Kids.

I mean that's a whole different model that we're learning from and so how do we look at North America and are there opportunities there?

So we believe there is growth or, obviously, we wouldn't be this excited about the acquisition.

Hopefully, that answered your question.

The next question comes from Dylan Carden with William Blair.

Just curious how you guys were planning inventory sort of into the quarter?

And how much of the upside was -- were you able to chase in between and/or what was planned?

And how those have trended, kind of, moving into back-to-school and then to holiday?

I will tell you we've been talking and that we mentioned this in the past couple of calls really about cost of goods available for sale for the full season.

We've found ourselves I think in the past looking too much to what's August BOP look like, what's February BOP?

And the reality is, if we're going to go after as Jared had mentioned earlier these troughs in our business, we've got to be able to put inventory in the stores whenever we are in these kind of the periods, especially when you're going after the Kids business in a meaningful way.

So I feel very good that the goods available for sale, we have planned for the fall season are aligned with the kind of comp increases that we are expecting for the organization.

So we're feeling pretty good about the inventory position.

Also, I think Jim and our women's team have done a fantastic job of keeping open-to-buy available so that we have been able to chase.

And I think we're much closer to the day that we need it in the store right now as to when we're placing the order than, I think, we've been in my history here.

So I think the team has done a really, really good job of remaining liquid.

Jared, anything?

The only thing I would add to that is, you saw over the last 2 years, when sort of we were righting the ship and getting inventory disciplines in place, you saw us pulling down falling down inventory, and as we said at the beginning of this year, we wanted to go into offense, especially in the (inaudible) categories and still support Kids and Athleisure.

So we were expecting to see an overall, general goods available for sales increase to match the comp.

Still, when you look at it from a 2-year basis, we are still very, very low and, I think, very happy with where we stand.

I think it's a good point, Jared.

And I think, Dylan when you think about what we've been doing, it has been, let's be very focused on the areas where we're going to make investments, so in the seasonal category, in the Athleisure space, in the Kids space.

And I was just sharing with the team yesterday, when we looked at our results for Q2, the real comp that we drove the business with, it happened in those categories.

And so our inventories were also invested in those categories.

So I really, really like how our -- Debbie and our merchant team have built their assortment plan.

The next question comes from Steven Marotta with CL King & Associates.

I wanted to just ask a question regarding the children's footwear, if you can talk a little bit about the contribution in the second quarter, but moreover, part of the motive of putting children's in the stores was getting that add-on purchase from the mom that's bringing the child into the store.

Can you talk a little bit about how that's being measured and what kind of progress you're making on those add-ins either on unit per mom or per transaction?

Or you can just talk a little bit about how children is benefiting not you not just in that category but in other categories as well?

Steven, thanks.

That's a great question.

And I think you might recall 3 years ago when we talked about getting into Kids, it wasn't necessarily about getting kids' sales, it was about retaining her once she had a child in her home and the metric we're looking at obviously is, are we getting a larger share of her closet as a result of adding Kids?

And what we've seeing is, that we're getting that kids’ transaction, we are retaining the adult transaction.

So that's the best proof of incrementality.

So we're looking at that, our marketing team's done a great job of monitoring that, and we're really excited about the result we're seeing.

Okay.

I know you're often reticent to speak to quarter-to-date trends, and I wouldn't expect that to change now unless you decide that it should, but moreover, can you talk a little bit about the expectations for the back-to-school season now that Kids is in all of the stores?

I imagine there is specific marketing around it . And if, you are gaining that -- retaining the customer and gaining that incremental sale, was that -- the upside to comps -- there's a potential upside to comp.

You could maybe talk about that dynamic as well in the third quarter.

Yes.

Steve, so certainly, we think that there is a big opportunity for us to play bigger into back-to-school season.

We saw that with our Phase 1 and Phase 2 launches.

Phase 3 came in, in spring and, so this Phase 4 just puts us well positioned to take advantage of that as a greater way.

To be perfectly honest, Roger and I are constantly looking at how big that Kids business is and the inventory we have against it, and so far, we haven't seen the top.

So we are looking forward to growing that business, and back-to-school will be an increasingly important part of our business model now and, as Roger said, we can look to our Canadian subsidiary and see how big of a business it drives.

So we're very excited about that.

Also going into the holiday season, the kids shoes does play a bigger giftable purchase than, necessarily, adults shoes do, so we're learning our way there, but Kids will continue to grow in our business and the attached sales that go with it we're excited about.

One quick follow-up question regarding the reward, could you talk a little bit about what reward penetration is currently?

And in other words, some concerns to the margin dilution associated with the new BIP program if that has occurred?

Or if you could just address that, that'd be helpful too.

Steve, I think we'd read some folks concerns about that, and I was surprised to see that because if you look at what we did with the program, what we did was we actually reduced essentially the cost of that reward.

We lowered the threshold of what it took to earn rewards, but ultimately, you got less back in your pocket.

But what it does is it brings more people into the game.

So that's where we have focused our efforts.

So we're really happy with the results we've seen.

We don't see it as being something that's going to impact our margins in a meaningful way.

If anything, the connection it's created with our consumer -- we keep talking about our mission of inspiring self-expression.

The best way to do that is to get them to engage in this program where they also then bring in the shoes that they currently have on their feet and they donate them to Soles4Souls and they earn reward points for that, which drives another engagement with our brand or another transaction.

It's a beautiful thing.

We are so, so lucky that whatever it was, 20 years ago, someone made the decision to start a rewards program at DSW, one more example of how innovative this organization has been, and we're going to leverage that in a meaningful way.

It will not dilute margin.

The next question comes from Paul Trussell with Deutsche Bank.

Roger, just want to understand the magnitude of the drivers of the meaningful 2Q results maybe a bit more.

You spoke about growth from Sandals, Athleisure, Kids.

Maybe you can just go into a few more details on how we should think about what kind of comp -- their contribution, each of those areas contributed.

Also, you mentioned strong digital growth, are you able to quantify that at all or at least speak to the contribution you saw online versus your brick-and-mortar business?

And then, Jared, all year long, retail is dealing with this calendar shift.

If you can maybe speak a little bit about the impact to 2Q and then conversely to 3Q from the quarter ending August 4 versus July 29, especially given that the second half implied guidance is a little bit lower than what The Street was already modeling?

And if you can maybe provide some details around the reasons for that?

Paul, I'll take the first part of that question.

I will tell you these results were really driven by 3 things.

And I mentioned this earlier, but first, it is about the people.

You look at the talent we have developed in this business, the talent we've acquired, those assets are paying off and we've invested in those folks and we're getting that return.

I think putting more hours on the floor so that we can drive conversion has been something we're really, really focused and should impact us this fall season in a more meaningful way.

And then I think another sort of unsung hero for us is, we expanded our bonus program this year so that it wasn't just the leadership team that got to play in that but how do we get every associate in this home office, how do we get more people engaged with this brand that are going to earn more money as a result of the success that we're generating.

I think that people element, to me, I think, has been the big one, and we're organizing ourselves in a way and rallying around how do we get sales?

How do we drive sales?

I think that's the first one.

The second on the product front, we'd -- we mentioned we're investing in seasonal and the sandal category was double-digit comp, obviously, as we had the plus 10%, but they were in the mid-teens, which is fantastic.

But what I'll tell you is when you look at that on a 2- or 3- or 4-year basis, we're still nowhere near where we used to be, as far as penetration.

So I think there is continued upside in sandals.

I think for fall, we're looking to do the same thing with boots.

And I know Kim and Jim and the rest of our team there have a history of when we invest inventory and when the product is right, we have fantastic boot seasons, and that's what we're going to do.

The investment at -- in Athleisure, again, we invested inventory, we got comps.

And we're going to continue that because we see our penetration in the overall market is significantly below where we are in other categories.

So we think there's upside.

Kids was off the charts as far as comps, so really amazing results, I think, around the product.

And then the third piece would be in the marketing.

When you look at what we did with the relaunch of rewards that you earn starts faster, there's a philanthropic slant, you get free shipping, all of these things -- those decisions were based on feedback we received from our customers, the beauty of having 25 million people in your rewards program is you can go talk to them.

And you're not making guesses when you're making big strategic decisions like this and Amy and our marketing team, they did just that.

And those investments we're making through our rewards program, through the digital investment are driving digital demand.

Our digital demand for the quarter was up 52% to last year.

I've listened to a lot of calls, I've looked at a lot of releases, I haven't seen anyone else that's exceeded that.

So I think again, the combination of those 3 things, that's what's working to drive our results.

From a calendar shift, Paul, I would say we actually saw some bad news in Q2 related to that, but it was almost an exact offset of some good news that we saw in Q1.

So for spring, we were relatively neutral from a calendar shift standpoint.

Where I think everyone on The Street has an opportunity to improve their model is really in Q4.

Again, we don't give quarterly guidance, but I will simply say The Street right now is significantly out of alignment with where we are in Q4 because of the calendar shift.

So we are seeing roughly about a $50 million decline in sales in the fourth quarter as a result of losing that 53rd week, and a calendar shift, where a week that we are also shifting out of is a bigger week than what we've picked up.

So I think that needs adjusted and Christina will be available to help you guys model that out, but I'd really focus on Q4.

I will reiterate, our comp percentage calc is on a like-for-like basis.

It is not impacted at all on a shifted calendar.

So we're just talking dollars there.

The next question comes from Camilo Lyon with Canaccord.

Many congrats on a great comp performance as well.

Just kind of following up on the prior line of questioning, you clearly had a phenomenal quarter to second quarter comp performance, as you've highlighted.

Just the back half implied guidance is just so you're going to go back down to a low single-digit comp.

So could you just help us understand the disparity between the 10% that you did in Q2 and the 1.5% or 2% that you're looking for in the back half?

And really what's holding you back, the momentum that you're clearly qualitatively speaking to versus what's in the plan from a comp perspective?

Sure, Camilo, and I will kind of take a little bit of the position that we took at the beginning of this year in wanting to let you know we've got our intentions and our investments lined up, and we intend to be making those again but we also want the flexibility to be able to react, if we don't see the same type of reactions that we saw in the spring to our investments that we made in the fall.

So from a -- some of the things that I will say are headwinds that we just want to call out, we are not relaunching our VIP rewards program in the fall like we did in the spring.

So we think we're going to see continued traction from that, but there was a nice boost related to getting lots of certificates out in people's hands for that VIP rewards relaunch.

We know -- as you know, as we've talked about, we are shutting down the Town banner but we're still working on an integration of the other 3 banners and getting some proper business disciplines installed up there.

So there is an appropriate amount of prudence related to our Canadian operations.

They are not in our comp calculations, but they are in our overall EPS guidance.

And we continue to want to have the flexibility on the inventory investments to make sure that we will see the traction.

All that being said, if we see the investments respond in the way that we saw in the spring, I very much anticipate we'll be able to have this conversation again in Q3.

So is that to say that your in-season -- going-into-season plan really calls for that low single-digit comp but anything in excess above that is described as your chase?

Is that a fair way to compartmentalize those 2?

Yes, chase and specifically response to chasing product, which is obviously a piece, but I also think we're seeing the same type of reaction from our digital marketing in the fall.

We actually have a bigger chance for it to respond, but it's also a point where a lot of other people are screaming very loudly with digital marketing.

So whether it resonates the same yet remains to be seen but we have good aspirations that it will.

Got it.

Is there a way to quantify what the initial relaunch of the VIP program added to the second quarter comps?

I don't think we're breaking that out right now.

Okay.

Fair enough.

And then, Roger, you talked about the benefits of private label and private brands.

You're pretty detailed in the way that you're looking at that part of the business and what it could afford you.

Is that to say that you are contemplating going deeper into sourcing element of the business such that you take on that production yourself to believe that you have a partner already that's producing private label goods for you currently?

Yes, Camilo.

I think we've been talking a lot internally about what's happening in this industry over the last 5 years.

And these are probably new data points for you but when you look at what's happened in the footwear industry, there is really 5 major, I would say, retail groups that have grown market share, DSW during that time period invested in primarily because we opened 120, roughly 120 doors in that window.

You've got Nordstrom, which obviously have done well with their -- the Rack in adding Rack locations.

The third is the athletic players, so obviously, the athleisure trend, as I'm sitting here wearing a sneaker today, that has created, I think, opportunity for all of those players.

Number four, the one that everybody talks about is Amazon.

But number five is the one that I think we're really focused on and that is our vendor partners, that technology has enabled them to go direct to the consumer.

And that has been a big challenge when you look at market share growth.

So while they are our partners, they're also, in some way, shape or form, competing against us.

And so as we think about how do we differentiate the assortments that we carry within our brand, we think one way to do that is to build out over private brand in a much larger way.

And I think you guys are very close to what other retailers have done.

We've built that up, but we've really hit, I would say, a ceiling at this point.

We've been roughly between 9%, 10%, 11% of our total really for the last 3 or 4 years.

So we think there is a way to break out of that, and we think one way to do that is to ultimately have our own ability to design, source product, and we think it's provides a differentiated assortment.

We think it gives us margin upside.

We think it creates a real -- you have to earn the right to be on our selling floor, we talk about that.

And we also think it can introduce us to new channels for growth.

So those are all things we're looking at as to how we can compete in this ever-changing retail footwear environment we're in.

Great.

And then just one final one, if I could squeeze it in for Jared.

Jared, you talked about some of the non-GAAP reconciliations.

I was just curious on the FX piece, if you could just explain that exclusion from the non-GAAP reconciliation a little bit deeper?

Because I think that it seems like that's part of the ongoing part of the business and the sort of FX gains or losses on translations.

I'm just curious as to the methodology behind that exclusion?

Yes, so much of that was just the accumulated OCI that had been accumulating over the course of us owning them as an equity investment.

So I agree with you on a go-forward basis, that would not be something that's excluded out.

This was more related to the time when we held them in a different capacity, not part of our ongoing operations.

Additionally, there was the recognition -- oh, gosh, when was it?

2015, I think, we decided to prefund the acquisition with some Canadian -- buying Canadian dollars.

We actually saw some good news at the time that we actually took into earnings because these were not invested yet.

They were sitting in cash, and the accounting rules say at that point, you recognize it.

When it's sitting in investments, you don't recognize it till the time that you liquidate those investments.

And between the time that we bought it and we saw it move in our favor and we had to recognize gains back in 2015.

Then it sat in investments and we didn't mark that to market per accounting guidance until you liquidate it.

There was the recognition of that liquidation.

But on an ongoing basis, I agree with you, that would not be something we would typically exclude out.

The next question comes from Jeff Van Sinderen with B. Riley FBR.

Just a question on the inventory.

Just wondering if you should expect inventory to be up similar magnitude at the end of Q3?

Yes.

I extend -- I re-echo Roger's point that we don't look at inventory on a day by -- at the end-of-the-quarter day only.

We look at our goods available for sale over time; and our goods available for sale over that quarter are slated to be in line with what our comp expectations are.

But as we look at what we think, our plan is for the end of Q3 it's not that far from where we ended up for Q2.

Jeff, I think -- and I'm certain there are others that are probably invested in why we're saying this -- but when we walk into our warehouses and it's historically, and you walk in and you have a warehouse that's at 65% or 70% of capacity -- so just think about that, you walk in, and visually, what you see is 30% of that box has no product on it -- that's not the image we want to portray to our consumer.

And we could see that in these troughs our conversion rate would drop from whatever our normal in the mid-30s down to below 30s or below that during these troughs.

So we have people coming to us in these windows of time, let's make certain we have products on the floor, regular-priced product on the floor that we can sell that we're in stock and we can show.

It doesn't mean we're going to go to 100% but the levels we had got into by pulling back our inventory over the last 3 years, I think it was damaging to our brand.

So that's why we're not real focused on what does it look like at August BOP or Feb BOP, but how're we managing across the entire quarter or across the entire season.

So I think again, I'd say at the August BOPs and the February BOPs, it's going to be a little different than what you might've seen in the past.

Okay.

And then as a follow-up to that, I know it's a relatively small part of your business, but any update you can give us on how you're thinking about the penetration of closeout buys or closeout product in your assortment at this point?

Just wondering, if that was a driver at all in Q2.

And then, I guess, sort of how we should think about the closeout or sort of those special-buy-type merchandise going forward.

Yes.

Jeff, I would say, there's -- we stayed about where we have historically been, so I don't see that being a big driver of increases or decreases in our total assortment, but we're going to sort of stay where we've been in that space.

The next question comes from Christopher Svezia with Wedbush.

Good job on the comps.

I guess first, just on the guidance, I just want a point of clarification, Jared, maybe for you.

Just the 160 to 175, that excludes the losses from Town Shoes stores you're closing.

Correct me if I'm wrong on that, but the revenue guidance, are you including the revenues from those stores as you wind them down?

Just maybe a little clarification about how that's incorporated or excluded from the numbers, both revenues and profit.

Yes, the -- any impact from the ongoing operations of the Town banner are excluded from all aspects of guidance.

Okay.

So excluded from revenues and extruded from profit?

That's right, correct.

Okay.

Got it.

With regard to the boot segment, I'm just curious how you're thinking and planning that category for fall relative to last year?

When you think about your inventory component, are you planning to build into that to drive comp?

Or are you planning more conservatively to chase into it where you can?

I know there are restrictions, but just any color about how you're thinking about that category as it applies to your -- as it pertains to your inventory and your comp expectation for back half?

Yes, I can take that question.

I think just as we did with sandals, we're taking a similar approach with boots, so that we're in inventory on key items.

There are boots that are selling now.

It's not the winter boot; it's more fashion boot.

So that's an important part.

And then, just again, like we did in sandals, making certain we're in stock on key items throughout third quarter and then chase the you-know-what out of it as we go throughout the season, and then seeing where the trends are at and we know we have a belief then where we think she's going to go in buying her boots and I love the track record that I our boot team has in this organization that when the consumer is voting for boots, we have demonstrated an ability to chase it.

So I think, again, we're playing it out just like what we did in sandals; we're doing that for boots in the fall season.

Okay.

Lastly, just on merchandise margins, I know you don't get into gross profit discussion per se, but you indicated the merchandise margins for DSW stores, I believe you said, was up in the second quarter.

And I think your view is, do you expect or building the business to continue or sustain that going into the back half.

Just correct me if I'm wrong, and maybe you can just talk about the puts-and-takes or the drivers to that whether it's sourcing, whether it's clearing, whether it's just how you're planning out the back half of the year.

Sure.

So the drivers in Q2, it was a combination of both IMU as well as markdown favorability; a little more coming from markdown favorable than from IMU, but we did see favorable sourcing operations produce some IMU upside.

So overall, I think you -- as you mentioned, we saw a nice uptick in our merch margin for the DSW segment.

For the back half, we are expecting a little more muted but still slightly positive merch margin for that DSW segment, and I would say most of that, right now, we slate it for coming from IMU.

There's some great work that our merchants are doing with the costing initiatives, and that's what we've got in our plan.

We're actually not expecting the same type of performance on markdown favorability, but, again, if we see the sell-throughs, like we saw in Q2, that should materialize in lower markdowns.

Okay.

That's helpful.

And just one point, though.

Is the merchandise margin improvement more skewed to Q3 than Q4 just in comparison year-over-year, is that a fair characterization?

I'm sorry, what was your question?

Is the merch margin improvement opportunity more skewed to Q3 than it is to Q4?

Yes.

Just given the comparisons there?

Yes.

The next question comes from Matthew Gulmi with Wells Fargo.

This is Matt on for Tom this morning.

Just on the kind of the gross margin, saw that they were about 8 points below the U.S. Is that a normal spread so to speak for the Canada business?

And if not, how should we think about the margin structure for that going forward?

Yes, as I mentioned at call -- or one of the callers earlier, we aren't -- we don't want to guide to margin either at the U.S. or to Canada, but I would say, in general, you are -- you should expect to see a lower margin profile for that Canadian business at least for now.

We have opportunities that we think to leverage the relationships that we have with our own vendors and that's something we're going to be working on, we actually have initiatives in place right now, but for right now they have gone to market as a smaller organization and have distributors in the middle for some of their goods.

Yes, I think it's a combination of both what Jared just said, but then also just the mix of the assortment.

Again, with roughly half of your assortment being Athleisure/Kids, which I think everyone is aware, those products carry a lower margin rate then you do on some of the more fashion-forward product.

So those are the 2 big factors as we look at what margin in Canada looks like.

This concludes our question-and-answer session.

I would like to turn the conference back over to Roger Rawlins for any closing remarks.

Thanks, everyone, for calling in.

I wanted to first just say thanks to all my teammates on this call.

I know we have a lot of folks from -- up in Canada listening in.

So, thank you.

Great to have you guys in the family.

And just congrats to everyone on a great Q2.

I think it's important, please stay focused on driving sales, merchants staying nimble, drive key items, all-door buys.

Marketing, keep driving traffic the way you are.

And then our sales team, when they come in to your warehouse or when the visit that website, let's find ways to convert them.

That's what they're looking for.

We can be there to inspire self-expression.

And then, obviously, the rest of us, let's just support those 3 teams in a big way.

So thanks, everyone, for a great Q2, and let's keep it up.

Have a great day.

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