DESIGNER BRANDS INC. Executive Overview and Trends in our Business
The volatile macro environment and business conditions have required us to be nimble and quickly adapt our business model. The business returned to profitability in the first quarter of fiscal 2021 for the first time since the onset of COVID-19. The following are examples of trends in our business and changes we have made in response to the impacts of COVID-19 and the current macroeconomic environment: •Inventory Management- COVID-19 negatively impactedNorth America and global economics, resulting in a drop in demand for our products, specifically in the seasonal and dress categories. Although the seasonal and dress categories remain depressed from pre-COVID-19 levels, we are beginning to see strengthened results and we are responding to the increased demand with increased production within ourCamuto Group business. We implemented inventory management actions that enabled us to reduce the number of markdowns in the first quarter of fiscal 2021, which has allowed us to invest more in direct marketing. •Changing Consumer Preferences- There has been a clear shift in consumer behavior and preferences to athleisure, which includes athletic and casual products, and away from dress and seasonal categories. We have modified receipts to match these expectations and continue to see opportunity ahead of us given our historic under-penetration in the athleisure space. Our business model remains flexible and we were able to increase production of brands produced byCamuto Group to match emerging demand in seasonal and dress categories during the first quarter of fiscal 2021. •Strength in Digital- With store traffic continuing to trend lower than pre-COVID-19 levels, our digital fulfillment options, such as Buy Online Pick Up in Store, Buy Online Ship to Store, and Curbside Pickup, coupled with our ability to use our stores for fulfillment, have continued to serve us well as our customers look for convenient ways to shop. We were able to generate strong digital demand during the first quarter of fiscal 2021, well above the digital demand for the same period last year. We anticipate that adapting to operating as a digital-focused retailer will have a lasting influence on how we operate moving forward. In addition, we believe that our increased penetration in the athletic market, coupled with our historical success in dress and seasonal and a fully integrated supply chain supported byCamuto Group , position us well to be a premier footwear retailer for all of the family's needs over the long term.
Impact of COVID-19 on our Results of Operations
InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak a pandemic. OnMarch 18, 2020 , to help control the spread of the virus and protect the health and safety of our customers, employees, and the communities we serve, we temporarily closed all of our stores in theU.S. andCanada . In addition, we took several actions in lateMarch 2020 to reduce costs and operations to levels that were more commensurate with then-current sales, including furloughs and pay reductions. As this continues to be an unprecedented period of uncertainty, we have made and may continue to make adjustments to our operational plans, inventory controls, and liquidity management, as well as reductions to our expense and capital expenditure plans. During the second quarter and into the third quarter of fiscal 2020, we re-opened all of our stores, discontinued the furlough program, and restored pay for our associates that had taken pay reductions. Beginning inJuly 2020 , we initiated an internal reorganization and reduction of our workforce with additional actions taken throughout fiscal 2020 and into the first quarter of fiscal 2021, resulting in the elimination of approximately 1,000 associate positions. Following the re-opening of stores, we experienced and have continued to experience significantly reduced customer traffic and net sales from historic periods prior to COVID-19, which included subsequent store closures and reduced hours in certain areas, primarily inCanada , where government-imposed restrictions were mandated. Our retail customers in the Brand Portfolio segment have had and are having similar experiences. Customer behavior has been and may continue to be slow to return to pre-COVID-19 patterns and levels, if at all. We have continued to serve our customers through our e-commerce businesses during the period that our stores were closed and beyond, but store closures and reduced customer traffic resulted in a sharp decline in our net sales and cash flows. The COVID-19 pandemic remains challenging and unpredictable. The ongoing and prolonged nature of the outbreak has continued to adversely impact our business and may lead to further adjustments to store operations, as well as continue to drive changes in customer behaviors and preferences, including reductions in consumer spending, which may necessitate further shifts in our business model. As such, the ultimate impacts of the COVID-19 outbreak to our businesses remain highly uncertain and will depend on future developments, including the widespread availability, use and effectiveness of vaccines, 17 --------------------------------------------------------------------------------
which are highly uncertain and cannot be predicted. As a result, we may have future write-downs or adjustments to inventories, receivables, long-lived assets, intangibles, goodwill, and the valuation allowance on deferred tax assets.
Financial Summary and Other Key Metrics
Net sales increased to$703.2 million for the three months endedMay 1, 2021 from$482.8 million for the three months endedMay 2, 2020 . The 45.6% increase in net sales was primarily driven by a 52.2% increase in comparable sales during the three months endedMay 1, 2021 , compared with depressed sales during the three months endedMay 2, 2020 due to the temporary closure of all stores beginning inMarch 2020 and continuing through the rest of the first quarter of fiscal 2020. During the three months endedMay 2, 2020 , we also maintained higher sales returns reserves while stores were unavailable to accept returns. During the three months endedMay 1, 2021 , we had lower Brand Portfolio segment sales due to reduced orders as our retailer customers have shifted towards athletic and casual offerings. During the three months endedMay 1, 2021 , gross profit as a percentage of net sales was 30.7% as compared to negative 5.5% for the same period last year. The change to a gross profit from a loss was primarily driven by increased sales during the quarter as compared to the first quarter of 2020. In the first quarter of fiscal 2020, in response to the impacts of the COVID-19 outbreak on our operations, we addressed the temporary closure of stores with aggressive promotional activity and significant inventory markdowns. These actions resulted in higher inventory reserves, increased shipping costs associated with higher digital penetration, and the deleverage of distribution and fulfillment and store occupancy expenses on lower sales volume during fiscal 2020. During the first quarter of fiscal 2021, tight inventory management resulted in being less promotional. Accordingly, gross profit as a percentage of net sales for the first quarter of fiscal 2021 tracked higher than the pre-COVID-19 rate, which was 29.7% for the first quarter of fiscal 2019. Net income for the three months endedMay 1, 2021 was$17.0 million , or$0.22 earnings per diluted share, which included net after-tax benefits of$7.6 million , or$0.10 per diluted share, primarily related to the the change in the valuation allowance on deferred tax assets. Net loss for the three months endedMay 2, 2020 was$215.9 million , or a loss of$3.00 per diluted share, which included net after-tax charges of$85.6 million , or$1.19 per diluted share, primarily related to impairment charges and integration and restructuring expenses.
Comparable Sales Performance Metric
The following table presents the increase (decrease) in comparable sales for
each segment and in total:
Three months ended
May 1, 2021 May 2, 2020
Comparable sales:
U.S. Retail segment 56.3 % (42.4) %
Canada Retail segment 10.0 % (32.4) %
Brand Portfolio segment - direct-to-consumer channel 6.8 % 92.8 %
Other NA (62.0) %
Total comparable sales 52.2 % (42.3) %
NA - Not applicable
We consider comparable sales, a primary metric commonly used throughout the
retail industry, to be an important indicator of the performance of our retail
and direct-to-consumer businesses. We include stores in our comparable sales
metric for those stores in operation for at least 14 months at the beginning of
the fiscal year. Stores are added to the comparable base at the beginning of the
year and are dropped for comparative purposes in the quarter in which they are
closed. Comparable sales include stores temporarily closed as a result of the
COVID-19 outbreak as management continues to believe that this metric is
meaningful to monitor our performance. Comparable sales include e-commerce
sales. Comparable sales for the Canada Retail segment exclude the impact of
foreign currency translation and are calculated by translating current period
results at the foreign currency exchange rate used in the comparable period of
the prior year. Comparable sales for the Brand Portfolio segment include the
direct-to-consumer e-commerce site at www.vincecamuto.com. Beginning with the
third quarter of fiscal 2020, comparable sales no longer include the Other
segment due to no longer having activity in the Other segment. The calculation
of comparable sales varies across the retail industry and, as a result, the
calculations of other retail companies may not be consistent with our
calculation.
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--------------------------------------------------------------------------------Number of Stores
At the end of the first quarter of fiscal 2021 and 2020, we had the following
number of stores:
May 1, 2021 May 2, 2020
U.S. Retail segment - DSW stores 516 521
Canada Retail segment:
The Shoe Company / Shoe Warehouse stores 118 118
DSW stores 27 27
145 145
Total number of stores 661 666
Results of Operations
Comparison of the Three Months Ended May 1, 2021 with the Three Months Ended
May 2, 2020
Three months ended
May 1, 2021 May 2, 2020 Change
(dollars in thousands, except per
share amounts) Amount % of Net Sales Amount % of Net Sales Amount %
Net sales $ 703,155 100.0 % $ 482,783 100.0 % $ 220,372 45.6 %
Cost of sales (487,044) (69.3) (509,243) (105.5) 22,199 (4.4) %
Gross profit (loss) 216,111 30.7 (26,460) (5.5) 242,571 NM
Operating expenses (200,814) (28.5) (187,221) (38.8) (13,593) 7.3 %
Income from equity investment 1,708 0.2 2,270 0.5 (562) (24.8) %
Impairment charges - - (112,547) (23.3) 112,547 NM
Operating profit (loss) 17,005 2.4 (323,958) (67.1) 340,963 NM
Interest expense, net (8,814) (1.2) (2,158) (0.5) (6,656) 308.4 %
Non-operating income (expenses),
net 806 0.1 (87) (0.0) 893 NM
Income (loss) before income taxes 8,997 1.3 (326,203) (67.6) 335,200 NM
Income tax benefit 8,029 1.1 110,345 22.9 (102,316) (92.7) %
Net income (loss) $ 17,026 2.4 % $ (215,858) (44.7) % $ 232,884 NM
Basic and diluted earnings (loss)
per share:
Basic earnings (loss) per share $ 0.23 $ (3.00) $ 3.23 NM
Diluted earnings (loss) per share $ 0.22 $ (3.00) $ 3.22 NM
Weighted average shares used in
per share calculations:
Basic shares 72,613 71,914 699 1.0 %
Diluted shares 76,976 71,914 5,062 7.0 %
NM - Not meaningful
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Three months ended Change
(dollars in thousands) May 1, 2021 May 2, 2020 Amount % Comparable Sales %
Segment net sales:
U.S. Retail $ 620,658 $ 377,073 $ 243,585 64.6 % 56.3%
Canada Retail 40,604 29,329 11,275 38.4 % 10.0%
Brand Portfolio 57,427 82,113 (24,686) (30.1) % 6.8%
Other - 13,623 (13,623) (100.0) % NA
Total segment net sales 718,689 502,138 216,551 43.1 % 52.2%
Elimination of
intersegment net sales (15,534) (19,355) 3,821 (19.7) %
Consolidated net sales $ 703,155 $ 482,783 $ 220,372 45.6 %
NA - Not applicable
The increases in comparable sales for all segments and in total consolidated net
sales was due to the temporary closure of all stores beginning in March 2020 and
continuing through the rest of the first quarter of fiscal 2020. Also during the
first quarter of fiscal 2020, we maintained higher sales returns reserves with
stores not being available to accept returns, which resulted in significantly
lower sales. During the first quarter of fiscal 2021, the sales returns rates
normalized to pre-COVID-19 rates. The Canada Retail segment continues to be
impacted by mandated closures and restrictions in certain key markets. In
addition, we had lower Brand Portfolio segment sales due to reduced orders as
our retailer customers have shifted towards athletic and casual offerings.
Gross Profit (Loss)- The following summarizes gross profit (loss) by segment:
Three months ended
May 1, 2021 May 2, 2020
% of Segment % of Segment
(dollars in thousands) Amount Net Sales Amount Net Sales Change
Segment gross profit (loss):
U.S. Retail $ 193,113 31.1 % $ (32,970) (8.7) % $ 226,083
Canada Retail 10,835 26.7 % (2,311) (7.9) % $ 13,146
Brand Portfolio 11,926 20.8 % 13,904 16.9 % $ (1,978)
Other - - % (5,428) (39.8) % $ 5,428
215,874 (26,805)
Elimination of intersegment gross profit 237 345
Gross profit (loss) $ 216,111 30.7 % $ (26,460) (5.5) % $ 242,571
The change to a gross profit from a loss was primarily driven by increased sales
during the quarter as compared to the first quarter of 2020. In the first
quarter of fiscal 2020, in response to the impacts of the COVID-19 outbreak on
our operations, we addressed the temporary closure of stores with aggressive
promotional activity and significant inventory markdowns. These actions resulted
in higher inventory reserves, increased shipping costs associated with higher
digital penetration, and the deleverage of distribution and fulfillment and
store occupancy expenses on lower sales volume during fiscal 2020. During the
first quarter of fiscal 2021, tight inventory management resulted in being less
promotional. Accordingly, gross profit as a percentage of net sales for the
first quarter of fiscal 2021 tracked higher than the pre-COVID-19 rate, which
was 29.7% for the first quarter of fiscal 2019. The Canada Retail segment
continues to be impacted by mandated closures and restrictions in certain key
markets, which resulted in deleverage impacts to gross margin when compared to
pre-COVID-19 gross margin rates. In addition, the lower Brand Portfolio segment
sales also results in deleverage of fixed royalty expenses included within cost
of sales.
20
--------------------------------------------------------------------------------Elimination of intersegment gross profit consisted of the following:
Three months ended
(in thousands) May 1, 2021 May 2, 2020
Elimination of intersegment activity:
Net sales recognized by Brand Portfolio segment $ (15,534) $ (19,355)
Cost of sales:
Cost of sales recognized by Brand Portfolio segment 10,935 12,134
Recognition of intersegment gross profit for inventory previously purchased that was subsequently sold to external customers during the current period
4,836 7,566
Gross profit $ 237 $ 345
Operating Expenses- For the three months ended May 1, 2021 , operating expenses
increased by $13.6 million over the same period last year, primarily driven by
the implementation of temporary leaves of absence without pay for a significant
number of our employees and reducing pay for nearly all employees not placed on
temporary leave in response to the COVID-19 outbreak for most of the first half
of fiscal 2020. Operating expenses as a percentage of sales improved to 28.5%
compared to 38.8% in the same period last year, but were still elevated compared
to the pre-COVID-19 rate for the first quarter of fiscal 2019, which was 24.9%
as a percentage of sales.
Impairment Charges- As a result of the material reduction in net sales and cash
flows due to the temporary closure of all of our stores beginning in the first
quarter of fiscal 2020, we performed an impairment analysis at the store-level.
During the three months ended May 2, 2020 , we recorded impairment charges of
$84.9 million for under-performing stores. In addition, during the three months
ended May 2, 2020 , we recorded an impairment charge of $6.5 million for the
Brand Portfolio segment customer relationship intangible resulting in a full
impairment due to the lack of projected cash flows over the remaining useful
life. Also, as a result of the material reduction in net sales and cash flows
and the decrease in the Company's market capitalization due to the impact of the
COVID-19 outbreak on macroeconomic conditions, we performed an impairment
analysis for goodwill and other indefinite-lived intangible assets. Our analysis
concluded that the fair value of the First Cost reporting unit within the Brand
Portfolio segment did not exceed its carrying value. Accordingly, during the
three months ended May 2, 2020 , we recorded an impairment charge of $20.0
million for the First Cost reporting unit in the Brand Portfolio segment,
resulting in a full impairment.
Income Taxes- Our effective tax rate changed from 33.8% for the three months
ended May 2, 2020 to negative 89.2% for the three months ended May 1, 2021 . The
negative rate for the three months ended May 1, 2021 is the result of
maintaining a full valuation allowance on deferred tax assets while also
recording net discrete tax benefits, primarily as a result of adjustments to our
estimated fiscal 2020 return reflecting implemented tax strategies. The rate for
the three months ended May 2, 2020 is the result of carry back of losses to a
tax year where the U.S. federal statutory tax rate was 35%.
Seasonality
Our business is generally subject to seasonal trends driven by the change in weather conditions and our customers' interest in new seasonal styles. New spring styles are primarily introduced in the first quarter and new fall styles are primarily introduced in the third quarter. Since the COVID-19 outbreak, we have not experienced the typical seasonal trends given the changes in customer behavior.
Liquidity and Capital Resources
Overview
Our primary ongoing operating cash flow requirements are for inventory
purchases, payments on lease obligations and licensing commitments, other
working capital needs, capital expenditures, and debt service. Our working
capital and inventory levels fluctuate seasonally. We are committed to a cash
management strategy that maintains liquidity to adequately support the operation
of the business and withstand unanticipated business volatility, including the
impact of COVID-19. We believe that cash generated from our operations, together
with our current levels of cash, as well as the use of our ABL Revolver, are
sufficient to maintain our ongoing operations, fund capital expenditures, and
meet our debt service obligations over the next 12 months.
21
--------------------------------------------------------------------------------Operating Cash Flows
For the three months endedMay 1, 2021 , net cash used in operations was$1.4 million compared to$39.5 million for the three months endedMay 2, 2020 . The decrease in cash used in operations was driven by the net income recognized in the first quarter of fiscal 2021 versus a net loss incurred during that same period last year as a result of the COVID-19 outbreak, after adjusting for non-cash activity including impairment charges and the change in deferred income taxes. This was partially offset by higher spend on working capital as business recovers from COVID-19 and the measures we implemented last year to manage our working capital to preserve liquidity, including delaying vendor and landlord payments while we renegotiate terms, reducing inventory orders, and significantly cutting costs.
Investing Cash Flows
For the three months endedMay 1, 2021 , our net cash used in investing activities was$5.6 million , which was due to capital expenditures. During the three months endedMay 2, 2020 , our net cash provided by investing activities was$10.0 million , which was due to the liquidation of our available-for-sale securities partially offset by capital expenditures of$14.6 million .
Financing Cash Flows
For the three months endedMay 1, 2021 , our net cash used in financing activities was$3.6 million compared to net cash provided by financing activities of$193.9 million for the three months endedMay 2, 2020 . During the three months endedMay 1, 2021 , we had net borrowings of$4.8 million from the ABL Revolver with payments on the Term Loan of$3.1 million . During the three months endedMay 2, 2020 , we had net borrowings of$203.0 million from the Credit Facility as a precautionary measure to increase our cash position and preserve financial flexibility considering uncertainty in theU.S. and global markets resulting from COVID-19.
Debt
ABL Revolver- OnAugust 7, 2020 , we replaced the Credit Facility with the ABL Revolver, which provides a revolving line of credit of up to$400.0 million , including a Canadian sub-limit of up to$20.0 million , a$50.0 million sub-limit for the issuance of letters of credit, a$40.0 million sub-limit for swing loan advances forU.S. borrowings, and a$2.0 million sub-limit for swing loan advances for Canadian borrowings. Our ABL Revolver matures inAugust 2025 and is secured by substantially all of our personal property assets, including a first priority lien on credit card receivables and inventory and a second priority lien on personal property assets that constitute first priority collateral for the Term Loan. The amount of credit available is limited to a borrowing base based on, among other things, a percentage of the book value of eligible inventory and credit card receivables, as reduced by certain reserves. As ofMay 1, 2021 , the ABL Revolver had a borrowing base of$400.0 million , with$104.8 million outstanding and$5.3 million in letters of credit issued, resulting in$289.9 million available for borrowings. Borrowings and letters of credit issued under the ABL Revolver accrue interest, at our option, at a rate equal to: (A) a base rate per annum equal to the greatest of (i) the prime rate, (ii) the overnight bank funding rate plus 0.5%, and (iii) the adjusted one-month London Interbank Offered Rate ("LIBOR") (as defined) plus 1.0%; or (B) an adjusted LIBOR per annum (subject to a floor of 0.75%), plus, in each instance, an applicable rate to be determined based on average availability, with an interest rate of 3.0% as ofMay 1, 2021 . Commitment fees are based on the unused portion of the ABL Revolver. Interest expense related to the ABL Revolver includes interest on borrowings and letters of credit, commitment fees and the amortization of debt issuance costs. Term Loan- OnAugust 7, 2020 , we also entered into a$250.0 million Term Loan. The Term Loan requires minimum quarterly principal payments with the remaining outstanding balance due inAugust 2025 . The Term Loan has limited prepayment requirements under certain conditions. The Term Loan is collateralized by a first priority lien on substantially all of our personal and real property (subject to certain exceptions), including investment property and intellectual property, and by a second priority lien on certain other personal property, primarily credit card receivables and inventory, that constitute first priority collateral for the ABL Revolver. Borrowings under the Term Loan accrue interest, at our option, at a rate equal to: (A) a base rate per annum equal to the greater of (i) 3.25%, (ii) the prime rate, (iii) the overnight bank funding rate plus 0.5%, and (iv) the adjusted one-month LIBOR plus 1.0%, plus, in each instance, 7.5%; or (B) an adjusted LIBOR per annum (subject to a floor of 1.25%), plus 8.5%, with an interest rate of 9.8% (effective interest rate of 11.8% when including the amortization of debt issuance costs) as ofMay 1, 2021 . 22 -------------------------------------------------------------------------------- Debt Covenants- The ABL Revolver contains a minimum availability covenant where an event of default shall occur if availability is less than the greater of$30.0 million or 10.0% of the maximum credit amount. The Term Loan includes a springing covenant imposing a minimum EBITDA covenant, which arises when liquidity is less than$150.0 million . In addition, the ABL Revolver and the Term Loan each contain customary covenants restricting our activities, including limitations on the ability to sell assets, engage in acquisitions, enter into transactions involving related parties, incur additional debt, grant liens on assets, pay dividends or repurchase stock, and make certain other changes. There are specific exceptions to these covenants including, in some cases, upon satisfying specified payment conditions. We are restricted from paying dividends or repurchasing stock until the third quarter of fiscal 2021 at the earliest, after which certain limitations apply. Both the ABL Revolver and the Term Loan contain customary covenants of default with cross-default provisions. Upon an event of default that is not cured or waived within the cure periods, in addition to other remedies that may be available to the lenders, the obligations may be accelerated, outstanding letters of credit may be required to be cash collateralized and remedies may be exercised against the collateral. As ofMay 1, 2021 , we were in compliance with all financial covenants.
Capital Expenditure Plans
We expect to spend approximately$35.0 million to$45.0 million for capital expenditures in fiscal 2021, of which we invested$5.6 million during the three months endedMay 1, 2021 . Our capital expenditures for the remainder of the year will depend primarily on the number of store projects, as well as infrastructure and information technology projects that we undertake and the timing of these expenditures.
Critical Accounting Policies and Estimates
The preparation of our condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of commitments and contingencies at the date of the condensed consolidated financial statements and reported amounts of revenue and expenses during the reporting period. We base these estimates and judgments on factors we believe to be relevant, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The process of determining significant estimates is fact-specific and takes into account factors such as historical experience, current and expected economic conditions, product mix, and in some cases, actuarial and valuation techniques. We constantly re-evaluate these significant factors and make adjustments where facts and circumstances dictate. While we believe that the factors considered provide a meaningful basis for the accounting policies applied in the preparation of the condensed consolidated financial statements, we cannot guarantee that our estimates and assumptions will be accurate. As the determination of these estimates requires the exercise of judgment, actual results may differ from those estimates, and such differences may be material to our condensed consolidated financial statements. There have been no material changes to the application of critical accounting policies disclosed in our 2020 Form 10-K.
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