Designer Brands Inc.: Form 10-Q for the period ended Oct 28, 2023

EXECUTIVE OVERVIEW AND TRENDS IN OUR BUSINESS

For the third quarter of 2023, net sales decreased 9.1% and total comparable sales decreased 9.3% compared to the same period last year. Net sales during the third quarter of 2023 from our Owned Brands decreased 11.6% compared to the same period last year, with Owned Brands representing 25.8% of consolidated net sales, down from 26.5% for the same period last year. At the beginning of 2023, we completed the acquisition of Keds, expanding our Owned Brands' reach into casual and athleisure footwear in the wholesale and direct-to-consumer e-commerce channels and complementing the additions of Le Tigre and Topo during 2022. We believe these acquisitions represent significant steps taken toward our long-term goal of net sales from our Owned Brands reaching one-third of total sales by 2026. Gross profit as a percentage of net sales for the third quarter of 2023 was 40 basis points lower when compared to the same period last year, primarily due to promotional pricing and the deleveraging effect of lower sales on fixed occupancy costs, which more than offset lower logistics costs including freight, shipping, and distribution.

EFFECTS OF GLOBAL ECONOMIC CONDITIONS

Throughout 2023, a downturn in global economic conditions, most notably the growing concerns of a potential recession, rising interest rates, inflationary pressures, changes in employment levels, and significant foreign currency volatility, has adversely impacted discretionary consumer income levels and spending for our customers. Consumer spending on discretionary items, including our products, generally declines during periods of economic uncertainty, when disposable income is reduced, or when there is a reduction in consumer confidence. We are unable to predict the severity of macroeconomic uncertainty, whether or when such circumstances may improve or worsen, or the full impact such circumstances could have on our business.

During the second half of 2022 and continuing into 2023, our net sales declined as we experienced lower traffic and became more promotional under a more competitive landscape. Competitive pricing pressure has been exacerbated by a more promotional retail environment as the industry experienced a shift from tighter inventory positions to excess inventory and as macroeconomic conditions continue to impact discretionary consumer spending. These factors ultimately could require us to enact mitigating operating efficiency measures that could have a material adverse effect on business, operations, and results of operations.

FINANCIAL SUMMARY AND OTHER KEY METRICS

For the three months ended October 28, 2023:

• Net sales decreased to $786.3 million from $865.0 million for the same period last year.
• Gross profit as a percentage of net sales was 32.6% compared to 33.0% for the same period last year.
• Net income attributable to Designer Brands Inc. was $10.1 million, or $0.17 per diluted share, compared to $45.2 million, or $0.65 per diluted share, for the same period last year.

Comparable Sales Performance Metric- The following table presents the percent change in comparable sales for each segment and in total:

21

We consider the percent change in comparable sales from the same previous year period, a primary metric commonly used throughout the retail industry, to be an important measurement for management and investors of the performance of our direct-to-consumer businesses. We include in our comparable sales metric sales from stores in operation for at least 14 months at the beginning of the applicable 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 the e-commerce sales of the U.S. Retail and Canada Retail segments. 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 include the e-commerce sales of the Brand Portfolio segment from the direct-to-consumer e-commerce site for the Vince Camuto brand. The e-commerce sales for Topo, Keds, and Hush Puppies will be added to the comparable base for the Brand Portfolio segment beginning with the first quarter of 2024, the second quarter of 2024, and the third quarter of 2024, respectively. 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.

Number of Stores- As of October 28, 2023 and October 29, 2022, we had the following number of stores:

22

RESULTS OF OPERATIONS

THIRD QUARTER OF 2023 COMPARED WITH THIRD QUARTER OF 2022

(amounts in thousands, except per share amounts)

NM - Not meaningful

NET SALES

The following table summarizes net sales by segment:

(dollars in thousands)

For the three months ended October 28, 2023, net sales decreased in the U.S. Retail segment with $68.0 million of the decline due to the decrease in comparable sales and the majority of the remaining decrease due to the impact of store closures since the end of the third quarter of 2022. The decrease in comparable sales for the U.S. Retail segment was largely driven by a decrease in comparable transactions of approximately 6%, driven by lower traffic, and a decrease in the comparable average sales amounts per transaction of approximately 4% as we were more promotional than we were during the same period last year. Net sales decreased in the Canada Retail segment primarily due to lower comparable sales. The decrease in comparable sales for the Canada Retail segment was primarily driven by lower comparable average sales amount per transaction. Net sales for the Brand Portfolio segment decreased with approximately $34.0 million of the decline due to lower wholesale sales as retailer customers continued to pull back on orders, partially offset primarily from the net sales added from acquired Topo and Keds businesses.

GROSS PROFIT

The following table summarizes gross profit by segment:

(dollars in thousands)

The decrease in consolidated gross profit was primarily driven by the decrease in consolidated net sales during the three months ended October 28, 2023 over the same period last year, partially offset by lower freight and shipping costs for all segments and lower distribution costs in the U.S. Retail segment as we realized the benefit of moving our digital fulfillment activities from our Ohio location to our New Jersey location. Gross profit as a percentage of net sales decreased by 120 basis points for the U.S. Retail segment when compared to the same period last year, primarily due to promotional pricing and the deleveraging effect of lower sales on fixed store occupancy costs, which more than offset lower logistics costs including freight, shipping and distribution. Gross profit as a percentage of net sales decreased 280 basis points for the Canada Retail segment when compared to the same period last year, primarily due to a mix shift in sales towards lower margin products and the deleveraging effect of lower sales on fixed store occupancy costs. Gross profit as a percentage of net sales increased 830 basis points for the Brand

Portfolio segment when compared to the same period last year, primarily due to the change in mix of products sold, improved inventory positions, and lower freight costs.

The net recognition (elimination) of intersegment gross profit consisted of the following:

(in thousands)

OPERATING EXPENSES

For the three months ended October 28, 2023, operating expenses increased by $8.6 million over the same period last year, primarily driven by an increase in marketing expenses and the additional operating expenses from the acquired businesses, partially offset by lower store payroll in line with lower sales. Operating expenses, as a percentage of net sales, increased 370 basis points over the same period last year, due to higher marketing expenses and the deleveraging of costs on lower sales.

INTEREST EXPENSE, NET

For the three months ended October 28, 2023, interest expense, net, increased by $3.9 million over the same period last year, primarily driven by overall higher interest rates on our debt, with higher rates on the ABL Revolver over the same period last year and the addition of the Term Loan.

NINE MONTHS OF 2023 COMPARED WITH NINE MONTHS OF 2022

(amounts in thousands, except per share amounts)

NM - Not meaningful

NET SALES

The following table summarizes net sales by segment:

(dollars in thousands)

For the nine months ended October 28, 2023, net sales decreased in the U.S. Retail segment with $214.0 million of the decline due to the decrease in comparable sales and the majority of the remaining decrease due to the impact of store closures since the end of the third quarter of 2022. The decrease in comparable sales for the U.S. Retail segment was largely driven by a decrease in comparable transactions of approximately 7%, driven by lower traffic, and a decrease in the comparable average sales amounts per transaction of approximately 3% as we were more promotional than we were during the same period last year. Net sales decreased in the Canada Retail segment with $10.5 million of the decline due to the decrease in comparable sales and the majority of the remaining decrease due to the unfavorable impact from foreign currency translation. The decrease in the comparable sales for the Canada Retail segment was impacted primarily by lower comparable average sales amount per transaction. Net sales for the Brand Portfolio segment were flat to last year with the net sales added from the acquired Topo and Keds businesses offset by lower wholesale sales as retailer customers pulled back on orders.

GROSS PROFIT

The following table summarizes gross profit by segment:

(dollars in thousands)

The decrease in consolidated gross profit was primarily driven by the decrease in consolidated net sales during the nine months ended October 28, 2023 over the same period last year, partially offset by lower freight and shipping costs for all segments and lower distribution costs in the U.S. Retail segment as we realized the benefit of moving our digital fulfillment activities from our Ohio location to our New Jersey location. Gross profit as a percentage of net sales decreased 70 basis points for the U.S. Retail segment when compared to the same period last year, primarily due to the deleveraging effect of lower sales on fixed store occupancy costs, as well as being more promotional, partially offset by lower logistics costs including freight, shipping, and distribution. Gross profit as a percentage of net sales decreased 360 basis points for the Canada Retail segment when compared to the same period last year, primarily due to a mix shift in sales towards lower margin products and the deleveraging effect of lower sales on fixed store occupancy costs. Gross profit as a percentage of net sales increased 560 basis points for the Brand Portfolio segment when compared to the same period last year, primarily due to the change in mix of products sold, improved inventory positions, and lower freight costs.

The net recognition (elimination) of intersegment gross profit consisted of the following:

(in thousands)

OPERATING EXPENSES

For the nine months ended October 28, 2023, operating expenses decreased by $8.9 million over the same period last year, primarily driven by a decrease in incentive compensation and store payroll in line with lower net sales, partially offset by an increase in CEO transition, restructuring, integration, and acquisition costs, as well as the additional operating expenses from the acquired businesses. Operating expenses, as a percentage of net sales, increased 230 basis points over the same period last year, due to the lower net sales as we deleveraged our costs.

INTEREST EXPENSE, NET

For the nine months ended October 28, 2023, interest expense, net, increased by $11.8 million over the same period last year, primarily driven by overall higher interest rates on our debt, with higher rates on the ABL Revolver over the same period last year and the addition of the Term Loan.

LOSS ON EXTINGUISHMENT OF DEBT AND WRITE-OFF OF DEBT ISSUANCE COSTS

In connection with the settlement of our Term Loan on February 8, 2022, during the nine months ended October 29, 2022, we incurred a $12.7 million loss on extinguishment of debt, composed of a $6.9 million prepayment premium and a $5.7 million write-off of unamortized debt issuance costs. As a result of the replacement of the ABL Revolver during 2023, we also wrote off $0.2 million of debt issuance costs.

LIQUIDITY AND CAPITAL RESOURCES

OVERVIEW

Our primary ongoing operating cash flow requirements are for inventory purchases, payments on lease obligations and licensing royalty commitments, other working capital needs, capital expenditures, and debt service. Our working capital and inventory levels fluctuate seasonally.

During 2023, we had the following significant transactions that impacted our liquidity:

• On February 4, 2023, we completed the acquisition of Keds with $127.3 million in cash consideration, funded with available cash and borrowings on the ABL Revolver.
• On February 28, 2023, the ABL Revolver was amended to increase the available capacity under the revolving line of credit from $550.0 million to $600.0 million and to add a FILO Term Loan of up to $30.0 million, which was drawn in full, subject to a borrowing base.
• On June 23, 2023, we entered into a Term Loan that provides for a maximum aggregate principal amount of $135.0 million, which is made up of $50.0 million in loans taken during the second quarter of 2023 and delay draw loans available to borrow up to $85.0 million.
• The Term Loan was amended on September 21, 2023 to extend the date through which the delay draw loans remain available and on October 31, 2023, we borrowed $25.0 million of the delay draw loans with any remaining delay draw loans to be taken by January 31, 2024.
• We repurchased an aggregate 9.7 million Class A common shares, including open market purchases and purchases under the Tender Offer, at an aggregate cost of $102.1 million, including transaction costs and excise tax, under our share repurchase program. As of October 28, 2023, $87.7 million of Class A common shares remained available for repurchase under the share repurchase program.

We are committed to a cash management strategy that maintains liquidity to adequately support the operation of the business, pursue our growth strategy, and withstand unanticipated business volatility, including the impacts of the global economic conditions on our results of operations. We believe that cash generated from our operations, together with our current levels of cash, as well as the availability under our ABL Revolver and Term Loan, are sufficient to maintain our ongoing operations, support seasonal working capital requirements, fund acquisitions and capital expenditures, repurchase common shares under our share repurchase program, and meet our debt service obligations over the next 12 months and beyond.

The following table presents the key categories of our condensed consolidated statements of cash flows:

(in thousands)

OPERATING CASH FLOWS

The increase in net cash provided by operations was largely driven by lower spend on working capital during the nine months ended October 28, 2023 over the same period last year, due to the decreased investment in inventory with the slowdown in sales, as discussed above in the results of operations, and the timing of payments on liabilities, which was partially offset by the decrease in net income recognized in the nine months ended October 28, 2023 over the same period last year, after adjusting for non-cash activity including depreciation and amortization and the loss on extinguishment of debt and write-off of debt issuance costs.

INVESTING CASH FLOWS

For the nine months ended October 28, 2023, net cash used in investing activities was primarily due to the acquisition of Keds for $127.3 million and capital expenditures of $42.3 million relating to infrastructure and IT projects, new stores, and store improvements. For the nine months ended October 29, 2022, net cash used in investing activities was primarily due to capital expenditures of $41.9 million relating to infrastructure and IT projects and store improvements as well as our $8.2 million investment in Le Tigre.

FINANCING CASH FLOWS

For the nine months ended October 28, 2023, net cash used in financing activities was primarily due to the repurchase of 9.7 million Class A common shares at an aggregate cost of $102.1 million, payments of $15.7 million for taxes for stock-based compensation shares withheld, and payments of dividends of $9.3 million, partially offset by proceeds from the issuance of the Term Loan of $50.0 million and net receipts of $49.5 million from our ABL Revolver. For the nine months ended October 29, 2022, net cash provided by financing activities was primarily due to net receipts of $415.5 million from our revolving lines of credit, partially offset by payments of $238.2 million for the settlement of the Previous Term Loan, the repurchase of 10.7 million Class A common shares at an aggregate cost of $147.5 million, and the payments of dividends of $10.3 million.

DEBT

ABL Revolver- On March 30, 2022, we replaced our previous senior secured asset-based revolving credit facility with our current ABL Revolver, which was subsequently amended on February 28, 2023 and June 23, 2023. The amended ABL Revolver provides a revolving line of credit of up to $600.0 million, including a Canadian sub-limit of up to $60.0 million, a $75.0 million sub-limit for the issuance of letters of credit, a $60.0 million sub-limit for swing-loan advances for U.S. borrowings, and a $6.0 million sub-limit for swing-loan advances for Canadian borrowings. In addition, the ABL Revolver includes a FILO Term Loan of up to $30.0 million, which was drawn in full on February 28, 2023. The FILO Term Loan may be repaid in full, but not in part, so long as certain payment conditions are satisfied. Once repaid, no portion of the FILO Term Loan may be reborrowed. Our ABL Revolver matures in March 2027 and is secured by a first-priority lien on substantially all of our personal property assets, including credit card receivables and inventory. The ABL Revolver may be used to provide funds for working capital, capital expenditures, share repurchases, other expenditures, and permitted acquisitions as defined by the credit facility agreement. The amount of credit available is limited to a borrowing base formulated on, among other things, a percentage of the book value of eligible inventory and credit card receivables, as reduced by certain reserves. As of October 28, 2023, the revolving line of credit (excluding the FILO Term Loan) had a borrowing base of $518.9 million, with $300.6 million in outstanding borrowings and $5.0 million in letters of credit issued, resulting in $213.3 million available for borrowings.

Term Loan- On June 23, 2023, we entered into a Term Loan that provides for a maximum aggregate principal amount of $135.0 million, which is made up of (a) borrowings at closing of a $45.0 million U.S. loan and a $5.0 million Canadian loan (denominated in USD) and (b) delay draw loans available to borrow up to $76.5 million in U.S. loans and $8.5 million in Canadian loans (denominated in USD). The Term Loan was amended on September 21, 2023 to extend the date through which the delay draw loans remain available, and on October 31, 2023, we borrowed $25.0 million of the delay draw loans with any remaining delay draw loans to be taken by January 31, 2024. The Term Loan matures at the earliest of the date the ABL Revolver matures (currently March 2027) or five years from closing of the Term Loan (June 2028). The Term Loan is collateralized by a first priority lien on substantially all of our personal, real, and intellectual property and by a second priority lien on the assets used as collateral for the ABL revolver, primarily credit card receivables, accounts receivable, and inventory.

Debt Covenants- The ABL Revolver required us to maintain a fixed charge coverage ratio covenant of not less than 1:1 when availability is less than the greater of $47.3 million or 10.0% of the maximum borrowing amount. At any time that liquidity is less than $100.0 million, the Term Loan requires a maximum consolidated net leverage ratio as of the last day of each fiscal month, calculated on a trailing twelve-month basis, of (1) 2.25 to 1.00 for any trailing twelve-month period through February 3, 2024, and (2) 2.50 to 1.00 thereafter. Testing of the consolidated net leverage ratio ends after liquidity has been greater than or equal to $100.0 million for a period of 45 consecutive days. The ABL Revolver and the Term Loan also contain customary covenants restricting certain activities, including limitations on our 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 based on availability. As of October 28, 2023, we were in compliance with all financial covenants contained in the ABL Revolver and the Term Loan.

Termination of Previous Term Loan- On February 8, 2022, we settled in full the $231.3 million principal amount outstanding on that date under our Previous Term Loan. In connection with this settlement, during the nine months ended October 29, 2022, we incurred a $12.7 million loss on extinguishment of debt, composed of a $6.9 million prepayment premium and a $5.7 million write-off of unamortized debt issuance costs.

Refer to Note 11, Debt, of the condensed consolidated financial statements of this Form 10-Q for further information about our debt arrangements.

CAPITAL EXPENDITURE PLANS

We expect to spend approximately $55.0 million to $60.0 million for capital expenditures in 2023, $42.3 million of which was spent during the nine months ended October 28, 2023. Our future investments will depend primarily on the number of stores we open and remodel, infrastructure and IT projects that we undertake, and the timing of these expenditures.

RECENT ACCOUNTING PRONOUNCEMENTS

There are no recent accounting pronouncements that are expected to have a material impact to our consolidated financial statements when adopted.

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 and estimates disclosed in our 2022 Form 10-K.

We have market risk exposure related to interest rates and foreign currency exchange rates. There have been no material changes in our primary risk exposures or management of market risks from those disclosed in our 2022 Form 10-K.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

We, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded, as of the end of the period covered by this Form 10-Q, that such disclosure controls and procedures were effective.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

No change was made in our internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f)

and 15d -15(e), during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal

control over financial reporting.

As of the date of this filing, there have been no material changes to the risk factors as set forth in Part I, Item 1A., Risk Factors, in our 2022 Form 10-K.