Image source: The Motley Fool.
DESIGNER BRANDS INCÂ (DBI 2.18%)
Q2Â 2020 Earnings Call
Sep 3, 2020, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day and welcome to the Designer Brands Inc. Second Quarter 2020 Conference Call. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Stacy Turnof with Edelman. Please go ahead.
Stacy Turnof -- Senior Vice President, Investor Relations
Good morning. Earlier today, the company issued a press release comparing results of operations for the three months ended August 1st, 2020, to the three months ended August 3rd, 2019.
Please note that the 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 the company's public filings with the SEC. The company assumes 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 over the call to Roger.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Good morning, and welcome to Designer Brands' second quarter fiscal 2020 earnings call. I want to start off by thanking our teams for their continued efforts as we managed through a gradual reopening of stores that was completed on July 12th. This has been an overwhelmingly challenging time for our industry, but I am confident in Designer Brands' playbook to strategically and successfully navigate the current environment.
We will continue to execute against our strategic pillars of delivering differentiated products and offering differentiated experiences to drive growth. Importantly, we continue to uphold the highest safety protocols in stores, including increasing cleaning, supporting social distancing, monitoring the number of customers in our stores, creating safe try-on areas, and requiring all customers and associates to wear masks in every one of our stores.
We have and will remain focused on prioritizing the health and safety of our employees and customers. We continue to employ best-in-class safety measures in our stores, including providing PPE to our customers and employees.
Equally as important to us, is the long-term health of our business. In the second quarter, we took significant actions to protect ourselves amid this uncertain environment, including greatly improving our liquidity position, instituting cost controls, and aggressively rightsizing inventory through markdowns and aligning inventory and consumer demand.
We also narrowed our focus to the top-50 brands in footwear and reduced points of distribution for Camuto-produced brands, all while supporting our communities through our charitable and diversity and inclusion initiatives.
We remain acutely aware of our responsibility to support our communities during this time. As we discussed last quarter, we have teamed up with Reebok and long-term partner, Soles4Souls, to provide over 100,000 pairs of footwear to essential workers and families impacted by COVID.
As of the end of this quarter, we have donated approximately 3.4 million pairs of shoes since the beginning of our partnership with Soles4Souls in 2018.
I want to acknowledge, we have challenges that will require us to believe in our ability to change. Many are business-driven; however, some are societal, by being honest about our opportunities to continue to make progress on diversity, equity, and inclusion.
While a lot of work remains, I'm encouraged by our continued progress to-date and how we will continue to infuse diversity, equity, and inclusion into who we are in all that we do.
We are hiring an experienced diversity, equity, and inclusion leader, who I will help support to drive organizational focus and change. We're asking our leaders to fully commit and embrace diversity, equity and inclusion through their performance and talent goals, and we are evolving our hiring approach, practices and policies.
We can do better, and we will do better.
We continue to feel the impact of COVID-19, and there are still a number of unknowns regarding what the future holds. And this is affecting how our consumers are shopping. According to data insights from Sense360 in an ongoing study, the percent of Americans believing the pandemic would last longer than six months has risen from just 9% in early April to just under 50% at the end of Q2. The environment remains incredibly fluid and it is critical that we adapt.
We're taking our learnings over the past six months, particularly related to consumer behavior changes, and adjusting our actions accordingly to better serve our customers' needs.
To protect the long-term sustainability of our business, we have taken further actions to enhance our liquidity and financial flexibility, in addition to the numerous steps taken to reduce our operating costs.
As announced on August 7, we recently retired our legacy cash flow revolving credit facility, entered into a new asset-based revolving credit facility and closed a new senior secured term loan. We expect that these measures will provide us with vastly more flexibility to efficiently manage our business and increase liquidity to weather a variety of scenarios on the road ahead. Jared will go into further detail on the liquidity measures we are taking in just a moment.
Additionally, we have taken numerous actions in terms of cost control initiatives. At the end of July, we made the difficult decision to implement an internal reorganization and reduce our workforce. This will allow us to realize annualized cost savings of approximately $40 million pre-tax, net of our planned reinvestments in the business. These actions were not taken lightly, but were necessary as we plan our business moving forward.
We also continue to have active discussions with all our partners to establish updated payment terms. We've aligned with vendors on new payment terms and are expecting them to strictly adhere to these going forward. As we work to be as efficient as possible, we continue to focus on ways we can optimize spend across the board.
Conversations with our landlords continue as we work to find more flexible lease terms, better matching lease obligations to traffic and sales. While we are still in the early stages of these discussions, the majority of our landlords have agreed to more flexible terms, helping to mitigate top line impacts from COVID.
As we evolve our approach, we are thinking differently about how to better provide our customers the products they want. Our flexible business model affords us the opportunity to quickly adapt to changing consumer preferences in challenging macro environments.
We're able to chase categories where we see strength; and in the near term, we're capitalizing on this flexibility to meet customers' needs. We continue to focus on emphasizing our everyday value proposition, prioritizing the top-50 brands in footwear and ensuring that we have a firm financial foundation.
With our customers staying home, we have seen a clear shift in consumer behavior and preferences by way of increased demand for athleisure product.
Even with the steep markdowns we applied to traditional seasonal and dress, customers are strongly gravitating toward comfortable and casual looks, as they spend much of their time at home and engaged in outdoor leisure activities. In response, we are flexing our agile business model and building our fall assortment to reflect consumer demand.
Receipts have been modified away from traditional seasonal dress toward athleisure, DSW's current highest performing category. Given our current under penetration in this business, we see a large market share opportunity ahead of us. Designer Brands has the flexibility and the necessary vendor relationships to become a go-to sneaker headquarters during this time.
In particular, we have had conversations with the top-five athletic brands in North America, who are excited about leveraging our platform to build their customer base. Our primary female customer base is a highly desirable audience for these brands, and we are currently underpenetrated in men's athletic footwear. So, all parties have much to gain from these potential partnerships.
At the end of the second quarter, in U.S. retail, our athletic business represented 24% versus 17% in 2019, and dress and seasonal represented 40% versus 47% in 2019. In the second quarter, we saw athletic comping down 24%, stronger than our overall store traffic, which was down 59%. Conversely, dress and seasonal are comping negative 66% and negative 47% respectively, reflecting changing consumer demand. In the fall season, we continue to plan for an increase in athletic penetration relative to normal levels to north of 25% of our assortment.
Furthermore, our merchandise margin rates on non-athletic and non-kids business was in the teens compared to mid-40s last year. Conversely, the balance of the assortment was much more in line with what we have seen historically. We are also increasing our assortment in evergreen categories like kids, as parents continue to need to replace their children's shoes. Comps are down 13% and kids' penetration has increased to 8% versus just 5% last year.
Our status as one of the largest retailers of footwear, coupled with our flexible business model, allows Designer Brands to command attention from the top-50 brands in footwear.
Customers are currently demanding products almost exclusively from brands they know and trust. Based on our site search data, we actually see consumers searching for shoes online by brand first, and then sorting on a specific type of shoe, such as sandals or sneakers.
As discussed last quarter, we plan to grow even grow even deeper with these top-50 brands. We know that our customer wants national brands more than ever, and we are prioritizing our inventory buys to reflect that. In response to this shift, we have strengthened our partnership with key brands that will result in DSW over-indexing on product allocated to us.
In certain cases, we are getting access to national brands that we have never had before. We're securing product in every style, color and size as these brands recognize our command of over 30 million rewards members and are positioned as a strong go-forward customer as other retailers are slowly disappearing.
We are being given more product choices and all major brands are expanding the breadth of assortment we can sell through. Some are even providing us with special makeup and closeouts in addition to their full line of goods, which we can offer to our customers at compelling price points. Customers will see a noticeable difference in our assortment and penetration within these top-50 brands in footwear starting this fall.
Our Canada business continues to perform strongly, especially given its already higher penetration in athleisure and kids. This allowed the shoe company to perform more in line with athletic and athleisure-focused retailers in the U.S., who are recovering more quickly from the impacts of COVID. We're taking learnings from our Canada business and applying them as we adjust our approach to the fall season in the U.S.
To support of our new initiatives and to build out our brand awareness, we have increased our marketing efforts across all channels, including TV, direct mail and digital. In late July, we launched our first TikTok campaign, which became one of the most successful commercial campaigns on the platform to-date. The campaign titled #TooManyShoes challenge, ignited by a partnership with J. Lo, featured an original song performed by up-and-coming artists, Julian Xtra and singer Devmo.
Additionally, we tapped several TikTok influencers to get on board. Today, videos with the #TooManyShoes have more than 3 billion views, bringing attention to DSW for a significant number of people who are not currently customers. This is just one example of the type of innovative marketing that we are implementing to influence a new set of potential customers to the DSW brand.
I'd like to take a moment to address our Camuto business. Not surprisingly, we have faced challenges in our Camuto operations, given its heavy focus on the dress business, one of the original reasons we purchased them.
Furthermore, the timing of the strategy to focus on Camuto's private label has proved unfortunate given the macro environment and the consumer pullback in this category due to the pandemic, and the wholesale business remains soft.
We believe that Camuto's capabilities will continue to be important as we look to provide everyday value to our customers and deliver our exclusive brands at a better value than ever before.
The integration remains on-track, but we continue to evaluate our operations, and we'll closely monitor consumer behaviors over the coming months, given the shift in consumer preferences as a direct result of the overhang of COVID-19.
To ensure our business is appropriately positioned amid this changing environment and to provide us more flexibility to chase into various categories, we have made the recent decision to shut down Sole Society and focus on Vince Camuto, Jessica Simpson, and Lucky, which are all tremendous brands for our company. This has been a challenging period as our store base was not fully opened during the quarter.
And while our weekly traffic in store generated demand saw material sequential weekly improvement upon reopening, we saw a definitive pause in that improvement near the middle of June. And we've been hovering with store traffic comping negative between 30% and 40%, fairly consistently since then.
Even with this stubborn store traffic pressure, demand for our athletic and kids product continues to fare much better and, in many weeks, actually comped positive, and we continue to flex our assortment toward these categories.
Until the consumer feels safe and comfortable going out and congregating in a meaningful way, we believe our store traffic will remain pressured. On the other hand, our overall digital demand comps remain robust with digitally demanded transactions for the quarter up over 40% versus last year. In the second quarter, our comps were down 43% compared to down 0.6% in Q2 2019, and total sales were down 43%.
Although sales at our stores remain challenged, our track record of smart, strategic digital investments has helped position us for success and driven continued strength in our online business.
With the rapid changing of the retail environment, we've accelerated our innovation and digital investments to meet the customer where they are. Digital demand grew by 27% at DSW U.S. during the quarter compared to the same period last year, and this represents 43% of total demand in the quarter compared to 19% last year.
Digital sales in Canada were also up considerably, a 154% compared to 2019. As we work on innovative ways to enhance and improve the shopping experience, a few key initiatives are working well. For example, Curbside Pickup and Buy Online, Pickup in-store, have appealed to shoppers who want to get product quickly but don't yet feel safe traveling into retail locations. We are seeing roughly 5.5% of e-commerce demand from these initiatives. We continue to use stores as fulfillment centers to optimize our geographic footprint and ship product rapidly.
Additionally, after successfully testing a self-checkout process housed in our app, we are rolling out a broader test to 37 retail locations. This self-checkout capability has not only improved safety in our stores, but also given us another touch point with our customer. Because the self-checkout experience takes place in our app, we are seeing more downloads, which gives us the opportunity to communicate with a greater number of customers digitally and increase engagement with our brand.
Finally, our website redesign has made finding and buying product virtually easier than ever.
In light of the dynamics of the quarter, we were aggressive with our promotional activity to drive sales, particularly in the dress and seasonal areas. Our markdown efforts enable us to clear through those categories to begin fall with a fresh position.
As a reminder, last quarter, we said that while gross margin rates would improve compared to Q1, they would still be very depressed in Q2 as we finalized our spring inventory cleanup. This did, in fact, occur. Also, we saw notable gross margin deterioration as a result of pricing actions taken in the quarter. However, we ended the quarter with inventory down 37% versus last year and anticipate returning to somewhat more normalized levels of merchandise margin rates in the fall, although still down versus last year.
Moving forward, we have significantly decreased future inventory receipts and refocused our orders on currently trending categories. The health of our inventory position allows us to chase into trends as they emerge, and this flexibility is a significant strategic differentiator for DBI.
Having adapted through the first several months of COVID, we have developed a pressure-tested and comprehensive plan, should we see another significant shutdown of business in North America.
In the early stages of the virus impact, we successfully moved to a digital-only offering. We know what the customer wants and we know how to deliver it to them -- be it digitally or in-person and socially distanced -- and we will be prepared in any situation. We have the flexibility to chase into trends and leave a significant portion of our inventory open to buy in order to do so.
We are prepared for the fall season with the heavier assortment of athleisure product and a spotlight on comfy cozy products, given the current consumer demand.
But if the market changes and consumers are headed back to the office, we expect to be able to flex our model to fit different scenarios and offer the assortment the customer wants.
We understand how to operate in a digital-only or digital-first retailer and are seeing our online engagement increase substantially. We have the liquidity to manage through a time where consumer demand is constrained.
COVID-19 continues to be a significant disruptor for our industry and visibility is still limited for the back half of 2020. As always, we are committed to updating you as we move through the rest of this year.
With that, I will turn the call over to Jared. Jared?
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Thank you, Roger, and good morning, everyone. Our second quarter continued to be materially impacted by COVID-19. Over the past six months, our team has taken numerous steps to run our business most efficiently as our industry and our economy worked to recover from the first waves of the virus and to prepare ourselves for long-term success.
Please note that the financial results that we will reference during the remainder of today's call excludes certain adjustments recorded under GAAP unless specified otherwise. For a complete reconciliation of GAAP to adjusted earnings, please reference our press release.
First, I will share the steps we have taken from a liquidity and cost perspective in more detail and briefly discuss our second quarter results.
Last month, we took additional actions to bolster our liquidity. We retired our $400 million revolving credit facility and entered into a new $400 million five-year asset-based revolving credit facility. This ABL revolver provides more flexibility to maneuver through this changing consumer landscape.
Along with the new ABL, we entered into a new financing arrangement, which included a new senior secured loan. With a support of Sixth Street, in early August, we announced the closing of a $250 million senior secured loan to further support the ongoing needs of the company.
Finally, we also want to remind you that in May, we suspended our dividends and share repurchases; and given the terms of the liquidity agreements I just described, we will continue to forego these.
Since February 1, 2020, we have drawn down $203 million and currently have approximately $214 million available for borrowing. We are comfortable with our balance sheet position and ended the second quarter with $206 million in cash. We continue to lower our capital expenditures significantly.
During the first half of fiscal 2020, capex was $22.1 million. We plan capital expenditures to be between $30 million and $35 million, well below last year's $78 million, as we have delayed our store openings and nonessential projects.
Since the pandemic began, we have been agile with regards to our expense structure across all areas of the company. Our stores remained closed for a large portion of the quarter, so we continue to see a reduction in payroll; and even as stores reopened, payroll levels were below normal given the flexible store labor model being driven off of depressed levels of in-store traffic.
On a positive note, we were happy to reduce the number of employees on furlough as we reopened our stores. In addition to the furloughs that we announced in the first quarter, we implemented a meaningful reduction in workforce at the end of July. This was a very difficult decision to make, but certain changes were necessary in order to strengthen our long-term financial position.
Additionally, we continue to negotiate with our landlords. During the quarter, we finalized deferral agreements with nearly all of our landlords covering the time our stores were closed. We are now focused on active discussions with our landlords to realign our rent and lease terms with traffic realities. As we prepare for the future, we are evaluating even more substantial options such as temporary or permanent closures of significantly underperforming stores.
We also reached agreement with all of our material vendor partners on arrangements for invoice payments that were disrupted during the initial months of COVID. At this point, nearly all of these disrupted amounts have been paid, and we have reached new go-forward payment terms with these material vendors that provide for extended time to pay, which more closely aligns with our anticipated inventory terms.
In total, we reduced adjusted operating expenses by $43.9 million in the second quarter, a sequential improvement from the $26.5 million reduction in the first quarter, and we plan to maintain a strict operating expense posture.
Moving to inventory. Our focus has always been maintaining healthy inventory levels that align with projected sales. We took numerous steps last quarter to end the spring season with clean inventory, implementing aggressive promotional activity and selective pricing activity, and we are happy with how the residual spring inventory is priced as we head into fall.
Total inventory was down 37% versus last year, and on a unit basis, inventory was down 17% to last year. Similar to the first quarter, we continue to have elevated inventory reserves against remaining yet-to-be-sold inventory of approximately $64 million, to address the excess spring 2020 and older inventory still on hand.
Additionally, fall receipts are planned down in total between 15% to 20% to last year with athletic and kids planned up double-digits and dress and seasonal planned down to reflect the consumer demand trends. We have kept a significant amount of flexibility with open-to-buy available to chase into trends as they develop throughout the fall.
Let's move on to our results. For the second quarter, net sales decreased 42.8% to $482.8 million, which included $6.6 million in intersegment revenue that is eliminated in consolidation.
For the second quarter, total comps were down 42.7% versus down 0.6% comp last year. In the U.S. retail segment, comp sales were down 44.9% during the second quarter versus down 1.5% last year. Keep in mind that stores in some of our largest geographies, such as the Northeast, were closed for a significant portion of the quarter, exacerbating the decline in sales.
As stores began to reopen, we saw a consistent pattern with demand comps improving eight to 10 points each week, nearly mirroring traffic comps. But in mid-June, overall growth trends began to slow as the pandemic surged again, especially in Florida, Texas, and California, all large markets for us.
On a relative basis, both kids and athletic performed well. Comps for kids were only down 13% as parents continued to replace products for growing children, while consumers sought comfort and footwear, supporting an at-home lifestyle, leading to the athletic category being down only 24%. These two categories significantly outpaced the other categories, as well as store traffic declines, supporting our decision to expand our penetration in these areas.
We were able to partially offset negative sales trends at our brick-and-mortar stores with strength in our e-com business. Digitally demanded net sales in U.S. retail were better relative to store performance, up 27% on top of a 22% increase for the same period last year.
We were pleased that online sales did not slow during the quarter even as stores reopened. In fact, we saw digitally demanded net sales for U.S. retail represent 43% of our total demand for the quarter versus 19% last year.
In Canada, comps were down 27.9% for the quarter. Despite the decline of the stores, results were partially offset by a strong digital growth, up 153.6% given the smaller digital base as a comparison and our strong and growing loyalty consumer base.
Let's turn to our Camuto Group. The pandemic could not have come at a worse time as it relates to our integration efforts at Camuto, a preeminent dress and seasonal footwear house. First, the wholesale business remains substantially challenged given the general condition of department store customers and decreased customer demand for product categories in which Camuto has historically dominated. We have seen our largest customers continue to cancel existing orders or hold off on placing new orders, which has led us to liquidate a high level of inventory.
Second and most importantly, the primary reason that we purchased Camuto was to support U.S. retail and exclusive brands and the strong sales synergies with their national brands. However, given that these products have traditionally focused on dress and seasonal products, the business is particularly challenged at the moment.
With strong aversion to public gatherings and shelter-in-place mindsets, we have seen the dress and seasonal categories significantly slow, leading to weakness within Camuto.
We will continue to closely monitor key indicators for that business but expect that the softness will continue through the back half, particularly as retailers pivot overall assortment toward athleisure and cozy products for the fall season.
Our strategy to increase our penetration of Camuto's exclusive brands in our assortment remains on hold until we see a change in the market environment and higher demand for these categories. For the time being, we have cut back on future production levels, reducing future production by approximately 73% for the balance of the year.
Total net sales for Camuto, including sales to U.S. retail were $30.5 million in the second quarter, down 70.4% versus last year. Wholesale sales were $15.6 million in the second quarter versus $88.6 million last year, including sales to our retail segments, which totaled approximately $4.5 million versus $16.5 million last year.
Commission income decreased 33.4%, including income from our own retail segments on exclusive brand business, which totaled $2 million for the quarter.
At ABG, comp sales were down 36.2% in the second quarter, driven by closures at many of our retail partners' locations. Within ABG is our partnership with Stein Mart, who announced in August that it has begun the Chapter 11 bankruptcy process. Although historically, a meaningful relationship, we have gradually been minimizing the contribution from Stein Mart in our budgeting and go-forward planning. As such, the financial impact of this event is not anticipated to be material to the current or future state of Designer Brands.
In anticipation of industry changes, we have been focusing on non-traditional partnerships, such as our recently announced agreement with Hy-Vee, to mitigate the impact that we have seen with traditional retailers.
Our adjusted consolidated gross profit decreased $220.9 million to $40.3 million in the second quarter versus $261.2 million in the prior year. Our consolidated gross margin was materially impacted by COVID-19, decreasing to 8.2% in the second quarter versus 30.5% in the prior year, but with a substantial improvement from the first quarter.
At our U.S. Retail segment, we saw a meaningful improvement in merchandise gross margin versus the first quarter despite continued pressure as we moved through inventory that we had reserved against in Q1. However, we took additional markdowns to continue liquidating the remaining spring inventory and deleveraged on fixed costs given year-over-year sales, as well as saw elevated shipping expenses as a result of increased digital sales.
Similar to the U.S. business, Canada's gross margin in the second quarter was 11.4%, a decline of 23 percentage points versus last year, but a sequential improvement over the decline in the first quarter. Trends in Canada were similar to the U.S., but relatively speaking, the business performed better given the higher concentration of athletic and kids.
Camuto adjusted gross margin rate was a negative 31.6% in the second quarter versus a positive gross margin rate of 26% last year. The gross margin decline was significantly greater than the first quarter as we had to take record level markdowns across the portfolio as a result of the changing consumer preferences and pressures facing Camuto's largest customers.
Moving to operating expenses. In the second quarter, consolidated SG&A for all of our businesses was down 20.6% to $169.2 million versus $213 million last year, as we took decisive actions to cut costs across our organization as a result of temporary store closures.
Given the significantly lower sales base, our SG&A ratio was 34.5% of sales, above last year's level of 24.9%. Depreciation and amortization totaled $20.9 million in the quarter compared to $21.1 million in the prior year.
Adjusted operating profit for Designer Brands was a loss of $126.7 million in Q2 versus a profit of $50.6 million last year. Interest expense was $3.8 million during the second quarter versus $2 million in the prior year.
Moving to taxes. Our effective tax rate for the quarter was 29.3% compared to 30.6% last year. We expect to see a notable cash tax benefit in 2021 related to the carryback rule of any net operating losses going back five years, which relates to the CARES Act and includes years in which the U.S. tax rate was 35% versus the current rate of roughly 21%. Total weighted average diluted shares during the quarter were $72.1 million compared to $74.3 million last year.
We reported a net loss of $98.2 million or $1.36 per diluted share, which included net charges of $0.08 per diluted share from adjusted items primarily related to impairment charges and restructuring expenses. Excluding these charges, adjusted EPS was a loss of $1.28 per diluted share for the quarter.
During the second quarter, we opened one store in the U.S. and closed one in Canada, resulting in a total of 522 stores in the U.S. and 144 in Canada.
I would now like to turn to our outlook. In March, we withdrew our guidance; and at this point, it still remains too difficult to estimate the continuing impact of COVID-19 on our consumer and on our business model. We will continue to refrain from providing guidance until we have better visibility.
Looking forward, we continue to see pressure at least for the next quarter or two on demand for non-athleisure product. And because dress and seasonal product are so integral to our DNA, we continue to believe we will see meaningful pressure on our topline versus historical performance even while we have taken swift and material actions to pivot strongly toward athleisure and comfort product in the near-term.
As a result of these dynamics, we are expecting sustained pressure on our consolidated sales and margins. We expect COVID-19 to continue to have a significant impact on business in the second half with sales modestly improving over the first half but still down notably versus last year, quite likely in the double digits.
Given we have taken significant markdowns and our inventory is in good shape, we expect our merchandise gross margin deterioration to slow in the back half of the year on a sequential basis.
With lower sales volumes, we anticipate a continued fixed cost deleverage, but at a slower rate. To mitigate this ongoing pressure across the business, we continue to focus on aggressive cost reductions, including rent relief and vendor negotiations. It should be noted, however, that there will be approximately $50 million of non-cash expense items in the fall; and given the work we've done with payment terms and inventory management, it is feasible that we could actually generate positive free cash flow in the second half.
As you heard from Roger, our long-term strategy for the business remains intact even as we adjust our near-term plans. We are a dominant player in the footwear space, and we are quickly adapting in this environment to meet changing consumer demand.
With that, we will open the call for questions. Operator?
Questions and Answers:
Operator
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Sam Poser with Susquehanna. Please go ahead.
William Tang -- Susquehanna -- Analyst
Hi. This is Will on for Sam. Thanks for taking our question. I wanted to ask, are you guys seeing any benefit from Nike's decision to continue to turn their wholesalers? I mean, are you seeing any improved availability of product or improved allocations?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Well, we've had lots of conversations with these top-50 brands. And what I'm really excited about is how all of them are sharing their interest in partnering with us, and that is both with their in-line assortments. It's with the special makeup opportunities and with closeout product.
And I think what we're seeing from every one of those brands is they're excited because we have 30 million rewards members with roughly 80% of them being female. So, that's a customer that those brands are targeting. And when you add in there that we are so underpenetrated in men's, specifically in athletic, they have growth potential with us.
So, I think those things all combined for each of those brands is why those brands have ultimately decided to invest more heavily with us.
William Tang -- Susquehanna -- Analyst
Got you. That's helpful. Thank you. And then, I guess, can you frame out the promotional environment going forward for you guys? And I know you said that you cleared through the vast amount of seasonal and dress product. Can you just -- can you frame how -- what it looks like over the balance of the year? And just -- and also with that, the marketplace as a whole, what are you seeing out there from a promotional standpoint?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
I mean, I think probably what I'll do -- I'll just give you sort of a sense of how things are performing for us as we're not going to get into the detail of Q3, but sort of our game plan.
And when you look at how we have flexed this business model as we go through fall to really focus on athleisure and this comfy cozy look is how we're describing it, we're seeing that our athletic business is running positive comps and driving margins a couple of points higher than last year. Our athleisure assortment now is representing 50% of our sales versus 35% last year and running margins greater than last year. And our kids business is steadily improving and we think back-to-school is going to be an elongated back-to-school period.
And I think as we've steered away from career and dress wear and the early reads we're getting around trail and booties, where we are investing for fall, and the fact that we have our inventories, as we headed into fall, down 37%, we're looking optimistically about how fall can play out. I mean, we can be in chase mode and we are invested in areas where we're seeing the consumer respond.
And that's the approach we're taking. And yes, people are going to be promotional. But frankly, we don't have a lot of that product to promote because we dealt with it in the first half.
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Yes. And one thing I would add to that, and we are very excited with what we're seeing in the categories that we've pivoted toward; and as Roger said, we're about 50% in those categories that are doing well. That still does leave though, the 50% that you heard the kind of trends we're seeing on those other ones. And so, as you guys are looking at your modeling, you've just got to balance that accordingly.
William Tang -- Susquehanna -- Analyst
Okay, great. Thank you.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
You're welcome.
Operator
Our next question today comes from Rick Patel with Needham & Company. Please go ahead.
Rick Patel -- Needham & Company -- Analyst
Thank you. Good morning and hope everyone is well.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Thanks, Rick.
Rick Patel -- Needham & Company -- Analyst
A question about the kids segment. So, nice to see the penetration increasing here. But can you talk about the outlook for the back half in light of the new back-to-school paradigm that's going on? I think you mentioned that kids and athletic would be up double-digits this fall. Just hoping for some color on just the kids part. Roger, you mentioned that you expect an elongated back-to-school season. I'm curious if that means that you expect sales to accelerate from where they are right now or whether you expect them to be consistently strong throughout?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
No. I think -- well, I'll give you a data point. I think we get this NPD data that we're able to track to, and this is why I'm excited and why we got into kids. In July, what we were able to see was that we performed about 20 percentage points better than other shoe retailers in the kids category. And that's why that penetration continues to increase. And what we're seeing is that this is going to last, I would describe it as sort of four weeks later. And in markets where we have the kid going back-to-school, meaning they're actually walking in a classroom, we're performing in line or better than last year and doing what we'd expected. Markets where it's sort of a hybrid, aren't performing as good as the ones where they're in school and then the ones where they all stay home.
I mean, obviously, it's no different than all the other social activities that if people have historically gone to church or to school or whatever it is, those folks that aren't performing those activities, they're not buying shoes the same way that others are.
So again, I feel good about how we've positioned kids and our performance. But it will be a longer window of time to get that selling. That's what we're seeing.
Rick Patel -- Needham & Company -- Analyst
And I know there was intra-quarter volatility given spikes in the virus in some of the big states. Can you talk about how much of a negative impact this cause in the second quarter? And do you expect these affected states to catch up to the rest of the fleet this fall? Or do you expect continued volatility going forward?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
It was -- we talked about this on the Q1 call that as things were ramping back up and stores were getting opened, we were seeing in those, let's call them, I say, mature markets, meaning they had been open for five or six weeks, where we were in that minus 20-ish kind of comp range in stores, while digital continued to grow in the 20% to 30% range.
And what we have experienced is, as those different markets get hit, we fall back to the minus 30% to minus 40% range is what we're seeing. I think the area where we have been hit harder, I think, than some other retailers is we heavily penetrate some major markets. New York metro is a big market for us; D.C. is a big market for us; Philadelphia is a big market for us. And those are areas where this thing has hit us harder than others. And for example, in some of those markets, we're -- we've been down in the 70% range, while the balance of the chain is in the minus 30-ish range and/or better.
And that's the area where we need to see some kind of improvement in those major markets, frankly, for store traffic. It doesn't mean we still can't sell the you know what out of digital opportunities. And we can't go get some amazing closeout buys that are attractive to those kind of markets that we can sell online. So, we're looking for other ways to engage customers in those markets. But those are the biggest headwinds, I would tell you, that we face.
Rick Patel -- Needham & Company -- Analyst
Thank you. All the best this fall.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Yes, thank you.
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Thanks, Rick.
Operator
And our next question today comes from Tom Nikic with Wells Fargo. Please go ahead.
Tom Nikic -- Wells Fargo -- Analyst
Hey, good morning, guys. Thanks for taking my question. I hope you're doing well and staying safe and healthy.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Thanks, Tom.
Tom Nikic -- Wells Fargo -- Analyst
I wanted to ask about the digital performance. There was a pretty stark difference between what you achieved in the DSW banner, which was good, and then the Canada growth, which was far stronger, much better. Like why was Canada so much stronger than the U.S.? And I guess, if there's any sort of -- is it category mix? Is it anything like that? I'm just trying to figure that out.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
I would tell you one, Mary Turner right now is smiling. She's the leader of Canada. But there's just significant differences in size, is what I would tell you. When you're running a $1 billion digital play that's been around for 12 years versus one that is fairly new and does not penetrate nearly as large as what we do in the U.S., that's one big piece.
And what I would tell you is, Tom, I think I'm actually really proud of the performance we had in dot-com in the U.S., growing at 27%. But we mentioned this in the script that transactions were actually up 40%. But we really leveraged that channel this quarter to liquidate goods, because we didn't have customers walking into stores. And so, we went after the non-athletic space in a big way.
And I would tell you, if we would have had -- if we'd have known a pandemic was going to hit and could have invested in athleisure inventory the way that some of our competitors are positioned already in advance, right? I'd tell you, we would have done a hell of a lot more business in dot-com; I mean, a lot more business, because we did not promote dot-com for an athletic standpoint.
We've been able to sell that stuff at regular price, and I think that's actually helping us in a big way. We're not running buy one get one on all these athletic brands. And I'm so excited about that. And that's why as we think about the fall and go forward, these brands are doubling down with us because they see we can sell their product without having to discount. And even some of those brands for this fall, we're going to test through our digital channels being able to sell some curated apparel assortments within those brands, because we do not have to discount to sell athletic product. And I think that is going to help position us longer term with those brands.
Tom Nikic -- Wells Fargo -- Analyst
Got it. That makes sense. And just a quick clarification -- I'm sorry I may have missed it. I think you said what the overall inventory receipt plan was for the back half; can you just sort of run that by me again?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
No, Tom, we didn't. I mean, we're entering fall down 37%, and we are investing heavily in the athleisure product. We are investing heavily into -- I keep calling it comfy cozy. It's hard. I need to show you photos to get you to understand what it is. But think of it as you could sit on your couch in these shoes or you could walk through your mailbox in these shoes. And that's essentially the way that I'd describe it to our team. And we're getting after the bootie business, because we're seeing strength in trail in those kind of categories.
But outside of those categories, we're going to stay extremely lean in inventory. And we will chase it when the consumer gets more comfortable going back into those settings where that product is relevant.
Tom Nikic -- Wells Fargo -- Analyst
Got it. All right. Thanks for taking my questions and best of luck for the rest of the year.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Thanks.
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Thank you.
Operator
And our next question today comes from today comes from Gabby Carbone with Deutsche Bank. Please go ahead.
Gabby Carbone -- Deutsche Bank -- Analyst
Hi, good morning. Thanks for taking our question. So, with inventory meaningfully reduced going into the third quarter, just was wondering if you could provide any additional color on how gross margin could play out for the remainder of the year. What do you view to be some of the biggest headwinds? And where do you see opportunities for improvement?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Yes, Gabby, I think, again, in that athleisure space where we're trending above last year, that's roughly half of our assortment. That's very positive, because we cleaned up the non-athletic inventory in a way that we feel we're in chase mode.
I think we will still face some challenges simply because, in fashion, it's more challenging right now, and the fact that last year we were growing in a material way, our exclusive brands. And we've stepped back a bit on that simply because we want to invest more in these top-50 brands for now. And then also, obviously, some of the shipping, as we grow dot-com, which we anticipate continuing to kind of track we were on through the first half, some of those shipping challenges will ultimately impact our margin rate as well. But in general, we anticipate being closer aligned to where we were in the back half last year.
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Yes. The only thing I would add to that, Gabby, is -- and I mentioned this in my script, that merchandise margin Roger is talking to, we do anticipate with negative sales of any sort, you start to deleverage. And we do have our fixed cost occupancy in our gross profit calculation. And obviously, the increase in digital penetration, you've got associated shipping.
Gabby Carbone -- Deutsche Bank -- Analyst
Got it. That's helpful. And then just a follow-up. When it comes to store optimization, how are you thinking maybe your U.S. store count, given the strong shift to digital? And then I know using your stores as athletic centers has been a priority. Maybe if you can just talk a little bit more about that? Thanks.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
No, I think we're going to continue to lean into our warehouses and operate them as warehouses. And we're putting more and more product closer to the consumer in those warehouses, so that they have the ability to buy it when they're physically there as well as being able to ship it within, hopefully, at some point here soon, a couple of hours to their doorsteps.
So, I think that is -- that's been rooted in our strategy for years. But as it relates to the sort of the real estate portfolio, we're looking at many ways in which we can cut costs. And I think looking at that portfolio and having honest conversations with our landlords about the position of the business and ensuring that they're going on that journey with us, and if they don't, then we will be looking at -- if it means we have to exit some locations, we will do that.
We've been lucky enough to-date we've not had to do that because the landlords have worked with us and we're actually happy with the kind of percent rent deals and other things that we've been getting on on some of the deals that we've recently struck. Jared, I don't know if there's anything else you'd add.
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
No, the only thing I would say is we partnered with a consulting firm, A&G Realty. The deferral work was great. And we -- as I mentioned, we've reached negotiation -- reached deferrals on almost all of our landlords and leases. We are actively now talking about rent reductions.
And Roger mentioned it, where we have lease events happening, i.e. there's a termination or kick out coming, we have been able to successfully move to a percent of sales formula that is well below where we were pre-COVID. Even though it was fixed, when you look at it as a percentage of sales, we're well below that.
We are aggressively going after that. And there are some, even without a lease event, that we need to have that kind of partnership. And A&G is out there right now leading that discussion, and we'll have to make some tough decisions, but we think we've got some good opportunity.
Gabby Carbone -- Deutsche Bank -- Analyst
Great. Thanks for all the color. Best of luck.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Yes, thank you.
Operator
[Operator Instructions] Today's next question comes from Chris Svezia with Wedbush. Please go ahead.
Chris Svezia -- Wedbush -- Analyst
Good morning, everyone. Thanks for taking my questions and I hope you're all doing well.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Thank you.
Chris Svezia -- Wedbush -- Analyst
I guess, first, Jared for you, I appreciate cash is king here and your comments about possibly positive free cash flow in the second half. But I was wondering just kind of given the puts and takes of the model, do you feel like you'll be profitable as a total company in the back half of the year? Or any color you can give us just based on some of the parameters you gave about sales, to some degree, margins, things of that nature. Just how do we think about profitability in the second half of the year?
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Yes. Obviously, I'll start the conversation with: we don't have the visibility to provide guidance. But when you do look at what we've given color as far as continued sales pressures, so while we've got some great sales tailwinds with the pivot toward athletic, athleisure kids, comfy cozy, as I mentioned, you still have the other half of the business, which is down 50%, 60%, 70%.
And when you look at that, you couple it with our fixed cost infrastructure of the leases and just general cost and the margins that -- the margin dollars that don't flow through when you don't have those sales, I think it could be challenging to get to profitability in the fall. Not impossible. And if we see the trends, we think that there's certainly opportunities to do pretty well. But with current trends, I think that could be a challenge.
All that being said, we've got about $50 million of expense, fixed expense and depreciation and stock comp in the fall that is non-cash-related. And so, when you look at that, coupled with the work we've done on working capital, that's where we said there is possibility to still generate positive free cash flow.
Chris Svezia -- Wedbush -- Analyst
That's helpful. Thank you. And I guess, Roger, for you. When I think about -- if I kind of step back and look at the acquisition that you did, Camuto and its original intent, and obviously, I can appreciate sort of the comments of where the consumer is right now and how they're spending and sort of putting the private brand penetration on hold, but how -- I mean, it seems like that may last for some time into next year, these trends we're seeing in the market and athleisure. So, I'm curious how do you think about the operating cost model of the Camuto infrastructure? And are you at a point right now where it's leaning up, or is there additional action that could be taken? Or where is maybe light at the end of the tunnel for that strategy that you had put in place, call it, two years ago or so?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Yes. Thanks, Chris. I mean, as we've talked about this, we bought it to provide differentiated products for our retail channels. And I think that is the focus of the business. And I was really happy with how the product looked and what we had built from a spring assortment standpoint. And I think this -- to just frame up, 95% of what we sell is something that, ultimately, we control through our own direct-to-consumer experience.
So, the challenge we are faced with right now with Camuto is more on that 5%, which is the wholesale side. And we've got to work hard to do a better job of either growing sales or finding a way that we have to cut back our SG&A. And that's work that we're in the middle of. And I think I'll give you an example of some things we've done recently with these -- some of these latest changes in our org, we shut down roughly about a dozen brands that, frankly, we just didn't see progress in. And we are going to focus our efforts on Vince Camuto, on Jessica Simpson and Lucky, because those are three great brands that we know we can grow with our retail partners as well as within our own retail outlets.
Chris Svezia -- Wedbush -- Analyst
Okay. Okay. But I guess, just final follow-up on that; do you expect next year to start to ramp up again the private label initiative? I know you launched Mix No. 6, relaunched it again in the stores this year, but I'm just curious, the kind of the runway as you start to think about it next year to start to build back up again, or is it still completely off? And I'm just curious from a cost perspective, are the operating costs embedded in that business where they need to be, or is there more potential it can get done there to streamline that operation?
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Our goal when we acquired the business was to get to 25% to 30% of our business being through our exclusive brands, let's just say, Camuto-produced brands. And I don't think that plan has changed. I think the -- reaching that milestone is going to going to be out longer than what we had originally anticipated. Obviously, this whole pandemic impacted that in a material way. But again, we have to have differentiated products to support our long-term success. And I think the best approach to that is leveraging all the data we get from our selling channels and acting as a vertical retailer to be able to bring those goods to life for our customers.
And when you think about how exclusive brands is going to play out in the next 12 months, we've cut back our production levels in exclusive brands by about 70% for the balance of the year. But our plan is to get back in spring of 2021 to be something penetrated closer to where we were in early spring of 2020, which was in that 10% to 15% range.
So, that's where our efforts are focused. And then again, growing Vince, Jessica and Lucky, and we will address the SG&A in the event we don't see the kind of progress that we need over the next year.
Chris Svezia -- Wedbush -- Analyst
Okay. Got it. One final, just quick thing for me. Just on the taxes, Jared, just a clarification. I know many years ago, RBI, DSW, there were net loss carry-forwards that benefited DSW when the companies were combined. Is that how I'm looking at these tax losses is they just benefit cash flow, but on a reported basis your tax rate is still, whatever -- we'll say, 27%, 30%? Is that how we should look at this? It's a cash flow benefit for 2021?
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Yes. Yes. So, I mean the cash flow benefit in 2021 that I'm referring to is really all of the losses that we are generating this year. The CARES Act is giving us the ability to go backwards over the last five years and apply these losses to those last five years of taxable gains. That's a special exception. They had changed the rules that you had to only apply them go-forward. But that CARES Act is allowing us to go backwards up to five years. So, that's why we are anticipating a very sizable cash tax benefit.
I will say, as we look at the year in totality, you could see some lumpiness in our effective tax rate and that's really just a matter of you can only look at -- you've got to look at the last three years. And if you had a cumulative loss, then you've got to take valuation allowances against that. And we aren't there yet, but there's that possibility depending on what happens in the fall. You could see some real craziness shake out with the tax rate. It's all on the balance sheet, and the cash is going to come in regardless. But that's just a little precursor of some craziness we're looking at for the fall.
Chris Svezia -- Wedbush -- Analyst
Perfect. Okay. Sounds good. Appreciate it. All the best. Thank you.
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
Thank you.
Operator
And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Again, I know we have a lot of our associates listening on this call. Thanks for everything you're doing and let's get after it for the fall season. Thanks, everybody. Have a good day.
Operator
[Operator Closing Remarks]
Duration: 60 minutes
Call participants:
Stacy Turnof -- Senior Vice President, Investor Relations
Roger L. Rawlins -- Chief Executive Officer, Designer Brands and Interim President, DSW
Jared A. Poff -- Executive Vice President and Chief Financial Officer, Designer Brands
William Tang -- Susquehanna -- Analyst
Rick Patel -- Needham & Company -- Analyst
Tom Nikic -- Wells Fargo -- Analyst
Gabby Carbone -- Deutsche Bank -- Analyst
Chris Svezia -- Wedbush -- Analyst
