Designer Brands Inc.: Form 10-Q for the period ended Nov 2, 2024

EXECUTIVE OVERVIEW AND TRENDS IN OUR BUSINESS

For the third quarter of 2024, net sales decreased 1.2% and total comparable sales decreased 3.1% compared to the same period last year impacted by unseasonably warm weather and sustained uncertainty in the macro economic environment. During the third quarter of 2024, net sales from Owned Brands represented 25.1% of consolidated net sales, down from 27.5% for the same period last year. Gross profit as a percentage of net sales for the third quarter of 2024 was 31.8%, which was 80 basis points lower when compared to the same period last year.

Beginning in 2024, we changed how the Brand Portfolio segment sources certain Owned Brands for the U.S. Retail segment by transacting using a wholesale model, where intersegment sales and cost of sales are recorded, whereas in 2023 and prior we transacted on a commission model, where intersegment sales were based on a percentage of product cost. This change resulted in an increase in Brand Portfolio intersegment net sales, cost of sales, gross profit, and gross profit as a percentage of net sales and a corresponding increase in the amount of eliminated intersegment net sales, cost of sales, and gross profit with no impact to consolidated net sales, cost of sales, and gross profit.

EFFECTS OF GLOBAL ECONOMIC CONDITIONS

During the third quarter of 2024, our comparable sales declined as we experienced lower traffic, primarily in the U.S. Retail segment. 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 believe the decrease in comparable sales is a result of ongoing consumer concern of negative and/or uncertain economic conditions, most notably the concern of economic volatility, fluctuations in interest rates, inflationary pressures, and changes in employment levels. 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. These factors ultimately could require us to enact further mitigating operating efficiency measures that could have a material adverse effect on our business, operations, and results of operations.

FINANCIAL SUMMARY AND OTHER KEY METRICS

For the three months ended November 2, 2024:

• Net sales decreased to $777.2 million from $786.3 million for the same period last year.
• Gross profit as a percentage of net sales was 31.8% compared to 32.6% for the same period last year.
• Net income attributable to Designer Brands Inc. was $13.0 million, or $0.24 per diluted share, compared to $10.1 million, or $0.17 per diluted share.

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

19

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. For calculating comparable sales in 2024, periods in 2023 are shifted by one week to compare similar calendar weeks. 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. Stores added as a result of the Rubino acquisition that will have been in operation for at least 14 months at the beginning of 2025, along with its e-commerce sales, will be added to the comparable base for the Canada Retail segment beginning with the second quarter of 2025. Comparable sales include the e-commerce net sales of the Brand Portfolio segment from the direct-to-consumer e-commerce sites. 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 November 2, 2024 and October 28, 2023, we had the following number of stores:

20

RESULTS OF OPERATIONS

THIRD QUARTER OF 2024 COMPARED WITH THIRD QUARTER OF 2023

(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 November 2, 2024, net sales decreased in the U.S. Retail segment primarily driven by the decrease in comparable sales of $17.4 million. The decrease in comparable sales for the U.S. Retail segment was largely driven by a decrease in comparable transactions of approximately 4% due to lower traffic, partially offset by higher comparable average sales amounts per transaction of approximately 1%. Net sales increased in the Canada Retail segment primarily due to the addition of Rubino, with $8.1 million of net sales in the quarter, as well as $2.2 million from the net new stores opened since the end of the third quarter of 2023, partially offset by a decrease in comparable sales due to lower comparable average sales amounts per transaction. Unseasonably warm weather impacted boot sales during the fall season and contributed to the decrease in comparable sales in the Canada Retail segment. The increase in net sales for the Brand Portfolio segment was primarily due to a change in how we source certain Owned Brands for the U.S. Retail segment from a commission model, where sales were based on a percentage of product cost, to a wholesale model, where sales and cost of sales are recorded, which also resulted in the increase in intersegment net sales that are eliminated.

GROSS PROFIT

The following table summarizes gross profit by segment:

(dollars in thousands)

The decrease in gross profit for the U.S. Retail segment was primarily driven by the decrease in net sales during the three months ended November 2, 2024 over the same period last year and at lower margin rates. Gross profit as a percentage of net sales decreased for the U.S. Retail segment, when compared to the same period last year, primarily due to a change in mix of products sold as we continued to expand our athletic and casual offerings, which have lower margins than the seasonal and dress categories. The increase in gross profit for the Canada Retail segment was primarily driven by the increase in net sales during the three months ended November 2, 2024 over the same period last year. Gross profit as a percentage of net sales decreased for the Canada Retail segment also due to a change in mix of products sold. The increase in gross profit for the Brand

Portfolio segment was primarily driven by the transition of certain Owned Brands sourced for the U.S. Retail segment under a wholesale model, as discussed above, partially offset by higher freight costs. Gross profit as a percentage of net sales decreased for the Brand Portfolio segment due to higher freight costs compared to the same period last year as we rerouted supply chain lanes in order to avoid potential disruptions, partially offset by the benefits from the transition of certain Owned Brands sourced for the U.S. Retail segment under a wholesale model and the leverage of higher sales on royalty expense for products that do not have a royalty obligation.

The net recognition of intersegment gross profit consisted of the following:

(in thousands)

OPERATING EXPENSES

For the three months ended November 2, 2024, operating expenses decreased by $20.3 million over the same period last year, driven by a decrease in marketing expense of $8.7 million and a decrease in incentive compensation of $9.1 million as we have reversed incentive compensation recognized in previous quarters based on the performance of the business relative to our targets. Operating expenses, as a percentage of net sales, decreased 230 basis points over the same period last year due to a larger decrease in operating expenses on lower sales.

IMPAIRMENT CHARGES

During the three months ended November 2, 2024, we recorded impairment charges of $17.8 million with $9.2 million due to a vacated leased corporate office, $1.0 million due to an underperforming Canada Retail segment store, $0.6 million due to an underperforming U.S. Retail segment store, and $7.0 million due to the write-off of our equity investment in Le Tigre due to the inability of Le Tigre to generate earnings with expected future losses.

INTEREST EXPENSE, NET

For the three months ended November 2, 2024, interest expense, net, increased by $2.8 million over the same period last year primarily driven by a higher average debt balance.

INCOME TAXES

For the three months ended November 2, 2024 and October 28, 2023, our effective tax rate was a negative 20.2% and a positive 46.8%, respectively. The negative effective tax rate for the three months ended November 2, 2024 is the result of the change from a positive tax rate through the six months ended August 3, 2024 to a negative rate through the nine months ended November 2, 2024. The positive effective tax rate for the three months ended October 28, 2023 was higher than statutory rates due to the impact of permanent non-deductible compensation partially offset by federal and state valuation allowance adjustments.

NINE MONTHS OF 2024 COMPARED WITH NINE MONTHS OF 2023

(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 November 2, 2024, net sales decreased in the U.S. Retail segment primarily driven by the decrease in comparable sales of $38.9 million, partially offset by the added net sales due to the calendar shift in 2024 as a result of 2023 containing an additional week. The decrease in comparable sales for the U.S. Retail segment was driven by a decrease in comparable average sales amounts per transaction of 1% due to lower units per transaction with the remaining decrease due to lower traffic. Net sales increased in the Canada Retail segment due to the addition of Rubino, with $15.6 million of net sales during the period, as well as $5.6 million from the net new stores opened since the end of the third quarter of 2023, partially offset by the decrease in comparable sales due to lower comparable transactions and average sales amounts per transaction. The increase in net sales for the Brand Portfolio segment was primarily due to a change in how we source certain Owned Brands for the U.S. Retail segment from a commission model, where sales are based on a percentage of product cost, to a wholesale model, where sales and cost of sales are recorded, which also resulted in the increase in intersegment net sales that are eliminated. This increase in the Brand Portfolio segment was partially offset by lower sales to external customers as retail customers pulled back on orders during 2024.

GROSS PROFIT

The following table summarizes gross profit by segment:

(dollars in thousands)

The decrease in gross profit for the U.S. Retail segment was primarily driven by the decrease in net sales during the nine months ended November 2, 2024 over the same period last year and at lower margin rates. Gross profit as a percentage of net sales decreased for the U.S. Retail segment when compared to the same period last year primarily due to a change in mix of products sold as we expanded our athletic and casual offerings, which have lower margins than the seasonal and dress categories. The increase in gross profit for the Canada Retail segment was primarily driven by the increase in net sales during the nine months ended November 2, 2024 over the same period last year. Gross profit as a percentage of net sales decreased for the Canada Retail segment also due to a change in mix of products sold. The increase in gross profit for the Brand Portfolio segment was primarily driven by the transition of certain Owned Brands sourced for the U.S. Retail segment under a wholesale model, as discussed above, which also resulted in the net elimination of intersegment gross profit during 2024 as compared to the net recognition of intersegment gross profit for the same period last year (refer to the table below). Gross profit as a percentage of net sales increased for the Brand Portfolio segment primarily due to the transition of certain Owned Brands sourced for the U.S. Retail segment under a wholesale model, partially offset by higher freight costs in the third quarter of 2024 as we rerouted supply chain lanes in order to avoid potential disruptions.

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

(in thousands)

OPERATING EXPENSES

For the nine months ended November 2, 2024, operating expenses increased by $10.5 million over the same period last year, due to the addition of Rubino, with $3.9 million of operating expenses during the period, and the remaining increase primarily due to restructuring and integration costs and professional fees related to certain strategic initiative work. Operating expenses, as a percentage of net sales, increased 80 basis points over the same period last year due to an increase in operating expenses on lower sales.

IMPAIRMENT CHARGES

During the nine months ended November 2, 2024, we recorded impairment charges of $17.8 million with $9.2 million due to a vacated leased corporate office, $1.0 million due to an underperforming Canada Retail segment store, $0.6 million due to an underperforming U.S. Retail segment store, and $7.0 million due to the write-off of our equity investment in Le Tigre due to the inability of Le Tigre to generate earnings with expected future losses. During the nine months ended October 28, 2023, we recorded impairment charges of $0.6 million, primarily related to weather damage to a corporate office.

INTEREST EXPENSE, NET

For the nine months ended November 2, 2024, interest expense, net, increased by $11.9 million over the same period last year primarily driven by a higher average debt balance.

INCOME TAXES

For the nine months ended November 2, 2024 and October 28, 2023, our effective tax rate was a negative 7.9% and a positive 31.8%, respectively. The negative effective tax rate for the nine months ended November 2, 2024 was due to discrete tax benefits recognized, primarily related to the release of tax reserves no longer deemed necessary and state tax planning initiatives, which partially offset the tax calculated on income before income taxes at statutory rates. The positive effective tax rate for the nine months ended October 28, 2023 was higher than statutory rates due to the impact of permanent non-deductible compensation partially offset by federal and state valuation allowance adjustments.

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. On April 8, 2024, we acquired Rubino for $16.1 million in cash, funded with available cash and borrowings on the ABL Revolver. During the nine months ended November 2, 2024, we repurchased 10.3 million Class A common shares at an aggregate cost of $68.6 million. As of November 2, 2024, $19.7 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, 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 decrease in net cash provided by operations was largely driven by higher spend on working capital as we increased our investment in inventories and the decrease in net income recognized after adjusting for non-cash activity, including depreciation and amortization, stock-based compensation activity, and impairment charges, partially offset by the receipt of income tax refunds of over $40.0 million and no incentive compensation for 2023 being paid in the first quarter of 2024 whereas we did pay incentive compensation for 2022 in the first quarter of 2023. Other changes in working capital were the result of timing of payments with the calendar shift.

INVESTING CASH FLOWS

For the nine months ended November 2, 2024, net cash used in investing activities was primarily due to capital expenditures of $38.9 million relating to infrastructure and IT projects and new stores, including relocations, and the acquisition of the Rubino business for $16.1 million. 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.

FINANCING CASH FLOWS

For the nine months ended November 2, 2024, net cash provided by financing activities was primarily due to the net receipts of $113.0 million from our ABL Revolver, partially offset by the repurchase of 10.3 million Class A common shares at an aggregate cost of $68.6 million, and payments of $8.1 million for dividends and $4.3 million for taxes for stock-based compensation shares withheld. 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.

DEBT

ABL Revolver- The 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. 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. The ABL Revolver, which matures in 2027, 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 November 2, 2024, the revolving line of credit (excluding the FILO Term Loan) had a borrowing base of $506.8 million, with $384.1 million in outstanding borrowings and $4.4 million in letters of credit issued, resulting in $118.3 million available for borrowings.

Term Loan- On June 23, 2023, we entered into a Term Loan and have since borrowed the maximum aggregate of $135.0 million. 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).

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 November 2, 2024, we were in compliance with all financial covenants contained in the ABL Revolver and the Term Loan.

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

PLANS FOR CAPITALIZED COSTS

During 2024, we expect to spend approximately $60.0 million to $65.0 million that will be capitalized for property and equipment and implementation costs for cloud computing arrangements accounted for as service contracts, $46.5 million of which was spent during the nine months ended November 2, 2024. 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

The information related to recent accounting pronouncements as set forth in Note 1, Description of Business and Significant Accounting Policies - Recently Issued Accounting Pronouncements, of the condensed consolidated financial statements included in this Form 10-Q is incorporated herein by reference.

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 2023 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 2023 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 2023 Form 10-K.