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Tariff Mitigation, Warm Weather Drive Rocky Q3 for Designer Brands Inc.

Designer Brands Inc. (DBI) saw its stock fall by more than 18 percent Tuesday morning after the group’s most recent financial results revealed margin troubles and a significant earnings miss.

In a Nutshell: The parent company behind DSW, The Shoe Company and Camuto had a hard time keeping its business insulated from outside headwinds in the third quarterand it doesn’t expect that to change any time soon.

Unfavorable weather was one of several factors that hindered the company’s success throughout the quarter, according to DBI CEO Roger L. Rawlins.

“Due to the unseasonably warm weather in the critically important ‘Septober’ selling period, our historically busiest and most profitable time of the year, sales were affected at DSW, Camuto and in Canada,” Rawlins said during DBI’s Q3 conference call.

“As soon as it became apparent weather was becoming a meaningful impact, our team took a proactive stance to protect the top line and ensure our inventory positions were clean coming out of the busiest time of the year,” he said. “Our inventory was down 5.6 percent at the end of the third quarter in our retail businesses.”

Falling margins in the U.S. pushed DBI’s gross profit as a percent of sales down by 370 basis points. This was a result of both a promotional environment and higher shipping costs in the quarter, a consequence of higher e-commerce penetration, the company said.

This is a dire sign for the footwear retail group, C.L. King analyst Steven L. Marotta said.

“We view these results negatively, bordering on disastrous,” Marotta wrote in an email to Sourcing Journal. “Signs of stability and a turnaround were supposed to be in place by this time, though weak store trends early in the quarter forced heightened promotions later in the period, eroding gross margins. We thought we had accounted for the risk to earnings associated with this dynamic to approximately 5 cents to 10 cents on the year. That was not enough.”

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Another factor in DBI’s lackluster quarter was its sensitivity to trade uncertainty as a result of tariffs levied in the ongoing trade war. DBI has worked “tirelessly” to mitigate tariff impact by moving production out of China, “sharing costs” with vendors and supply chain partners, boosting raw material acquisition, using alternative components in its footwear and testing new in-store concepts, the company said.

The company trimmed its marketing budget in Q3, anticipating a consumer spending pullback, Rawlins said. This “disproportionately impacted” the group’s in-store consumers and led to more promotional pricing and greater penetration of more expensive e-commerce sales. The dress footwear category saw a comp 17 percent lower than the corresponding period in 2018 because of this effect, Rawlins said.

“We, of course, now know that the feared consumer pullback did not materialize. But we, unfortunately, were not able to make up the impact of these actions within the quarter. We’ve begun to restore the open-to-buy in these categories and continue to watch the actions around tariffs daily,” Rawlins said.

“As we look ahead, the unmitigated exposure to tariffs is incredibly meaningful to our business and we have found ways to mitigate the majority of the current tariffs across both DSW and Camuto,” Rawlins said. “However, especially at Camuto, the ability to mitigate 100 percent of the tariffs has proven to be challenging. And we now anticipate having the ability to mitigate approximately 80 percent to 90 percent.”

Sales: Designer Brands Inc. recorded net revenue of $936 million in Q3, up 12.4 percent over the comparable time period, thanks to the inclusion of DBI’s Camuto Group revenue and the consolidation of its Canadian operations. This result was higher than the $930 million predicted by Wall Street analysts but hindered by the fact that comparable sales inched up by 0.3 percent.

DBI said it would be lowering its year-end comparable sales outlook to “flat” from “up low-single digits.”

“Sifting through the rubble, with inventories in check and easing gross margin comparisons in the current quarter (and beyond), this will likely prove to be a gross margin trough,” Marotta said. “Comps begin to ease as well going forward. Camuto generated the first positive EBIT in Q3 since the acquisition. Lastly, the heavy promotions in Q3 worked at defending market share (as evidenced by the positive comp).”

Earnings: DBI generated earnings per share of 67 cents on net income of $43.5 million, notwithstanding pre-tax charges of $6.9 million related to “integration and restructuring expenses.” Wall Street EPS consensus for the group was 74 cents.

Much like its sales outlook, DBI lowered earnings projections for year-end to $1.50 to $1.55 diluted EPS from the previous range of $1.87 to $1.97.

CEO’s Take: Rawlins said DBI faced significant headwinds during the quarterheadwinds that might carry through multiple upcoming quarters.

“We continued to make progress on our strategic initiatives and the integration of our acquisitions. At the same time, we faced several meaningful headwinds during the third quarter that impacted our results and will likely continue for the upcoming quarters,” Rawlins said.

“We took proactive actions to protect our topline and delivered positive comps in the third quarter,” Rawlins added. “Our Camuto organization delivered their first positive operating income contribution in the quarter and the incredible Camuto designed and sourced exclusive brand product is being delivered to our warehouses currently and will be customer-facing in just a few weeks.”