DSW's (DSW) CEO Michael MacDonald on Q2 2014 Results - Earnings Call Transcript

Aug.26.14 | About: DSW Inc. (DSW)

DSW Inc. (NYSE:DSW)

Q2 2014 Earnings Conference Call

August 26, 2014, 08:30 AM ET

Executives

Michael R. MacDonald - President and CEO

Mary Meixelsperger - CFO

Deborah L. Ferrée - Vice Chairman and Chief Merchandising Officer

Christina Cheng - Senior Director of IR

Analysts

Mark Montagna - Avondale Partners

Taposh Bari - Goldman Sachs

Scott Krasik - Buckingham Research Group

Patrick McKeever - MKM Partners

Seth Sigman - Credit Suisse

David Mann - Johnson Rice

Christopher Svezia - Susquehanna Financial Group

Kelly Chen - Telsey Advisory Group

Camilo Lyon - Canaccord Genuity

Jeff Van Sinderen - B. Riley & Co.

Steven Marotta - C.L. King & Associates

Sam Poser - Sterne Agee

Operator

Good morning, and welcome to the DSW's Second Quarter 2014 Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note that the event is being recorded.

I would now like to turn the conference over to Christina Cheng, Senior Director of Investor Relations. Please go ahead.

Christina Cheng

Thanks Emily. Good morning, and welcome to DSW's second quarter conference call. Earlier today, we issued a press release detailing the results of operations for the 13-week period ended August 2, 2014.

Please note that various remarks made about the future expectations, plans and prospects of the company constitute forward-looking statements. Actual results may differ materially from those listed by these forward-looking statements due to various factors including those listed in today's press release and our public filings with the SEC.

Joining us today are Mike MacDonald, President and CEO; Debbie Ferrée, Vice Chairman and Chief Merchandising Officer; and Mary Meixelsperger, our Chief Financial Officer. Mary will start with a short discussion on our second quarter results and then highlight the details of our adjusted results for the second quarter and discuss her outlook for the full year. Mike will elaborate our results and then describe our progress on our strategic initiatives. After our prepared remarks, we will open the floor to Q&A.

With that, I will turn the call over to Mary.

Mary Meixelsperger

Thanks, Christina, and good morning, everyone. Our reported net income for the second quarter of 2014 was 34.3 million or $0.38 per share, which includes a benefit of $0.01 per share related to nonrecurring income from RVI. This compares against last year’s reported net income of 33.7 million or $0.37 per share, which included the net charge of $0.02 per share from our luxury test and a charge of $0.10 per share from the termination of RVI’s pension plan.

Excluding these items, adjusted net income was 33.6 million or $0.37 per share on 91 million shares outstanding compared to last year’s adjusted net income of 44.6 million or $0.49 per share on 92 million shares outstanding. Our equity investment in Town Shoes contributed $0.01 in earnings per share for the quarter.

All of my comments this morning regarding year-over-year comparisons will relate to adjusted results, which exclude one-time items from RVI in both years in our luxury test last year.

Sales for the quarter increased 5.2% from 558 million to 587 million in the current year. Comparable sales increased by 0.8% on top of an increase of 4.4% last year. Transactions for the DSW segment increased 5%. As the company noted before, we believe total transactions for the DSW segment better reflects the underlying dynamics of our business.

Store traffic declined in the low-single-digit range but improved substantially from Q1. Traffic to our website and mobile site increased by a healthy rate as more customers engaged with DSW online. Store conversion rate increased in the high-single-digit range. Charge-send fulfillment is also driving the healthy conversion increases. AUR declined in the low-single digits while units per transaction increased in the low-single digits for the segment.

We opened two new stores in the second quarter bringing us to a total of 410 stores in operations as of the end of the quarter. Although our new stores fell short of sales expectations in Q2, their performance improved materially from Q1 to Q2. We plan to open approximately 35 new stores in 2014.

In our Affiliated Business Group, second quarter comp increased by 2.5% on top of a 4.3% increase last year. Total sales grew by 6.9%. ABG ended the quarter with a total of 363 departments in operations, including a new Yellow Box retail store in Miami.

Gross profit for the quarter contracted 390 basis points with merchandize margin declining by 320 basis points. 210 basis points of the margin contraction was due to our aggressive clearance activity this year and had normally low markdowns in the prior year because of unusually low clearance levels.

Mix in pricing accounted for 40 basis points of the decline. Increases shipping expenses primarily from higher charge-send sales accounted for the remaining 70 basis points contraction. Occupancy and FCDC rates increased by 70 basis points primarily due to one-time items.

SG&A expenses were 15 basis points lower than last year with SG&A dollars increasing by 4.4%. Lower incentive compensation offset increases in omni-channel and IT expenses.

Turning to the balance sheet, we ended the quarter with cash, short and long-term investments of 465 million compared to 500 million last year. We invested $72 million in Town Shoes of Canada consisting of an equity investment of 24.8 million and a note receivable of 47.8 million.

Inventories for the DSW segment ended below last year by 3.3% on a cost per square foot basis. Clearance footwear units per average store were flat to the prior year. We are pleased with our inventory position going into the fall season and we are managing our inventories conservatively.

Capital expenditures for the second quarter were 22.7 million with 13.1 million spent on new stores and store remodels and 9.6 million spent on technology projects and improvement in our distribution and fulfillment centers.

I’d like to take a few minutes to discuss our capital allocation priorities. Growth both organic and non-organic is our number one priority. We are investing a 120 million in CapEx this year. About half of this CapEx goes to new stores and remodels and the balance to IT and business projects. Our stores provide very attractive four-wall profit rates.

Dividends and buybacks are DSW’s other two priorities. We have paid $34 million in dividends year-to-date for a dividend yield of 2.7% based on yesterday’s closing price. We would like to maintain an attractive payout over time. We also repurchased approximately 2 million shares for $55 million under our current stock buyback program during the quarter with 43.2 million remaining in our current authorization. We appreciate that dividends and stock buybacks create additional shareholder value.

Turning to guidance. We expect full year comparable sales to be flattish and full year total sales to increase in the mid-single-digit range. Due to markdown actions and heavy clearance this spring, we expect full year merchandize margins will be 100 to 150 basis points lower than last year as we previously stated last quarter.

As we start to see better sell-throughs of our fall product, we expect markdowns to normalize but sharper pricing and higher shipping costs are projected to cause merchandize margin to contract modestly in the back half. We expect SG&A expenses in dollars to increase in the mid teens range in the fall as we invest in omni-channel integration, marketing and IT. Mike will address the progress on these efforts more fully in his comments.

We are now projecting earnings per share to range from $1.50 to $1.65 based on a tax rate of 39%. Our guidance includes $0.02 per share from our equity investment in Town Shoes of Canada and assumes 91 million shares outstanding for the full year, which has been reduced to reflect the impact of shares repurchased so far this year.

With that, I will turn the call over to Mike.

Michael R. MacDonald

Thanks, Mary, and good morning, everyone. We saw continuous improvement in our selling metrics throughout the quarter with comps trending positive for all regions and all categories in the month of July. For the quarter, our stores in the South and the West outperformed while the North East and Mid Atlantic regions comped flat. Our Mid West region comped down in the low-single digits.

As Mary noted, our new stores fell short of their collective sales planning Q2 but they achieved improved sales performance in Q2 compared to Q1. We think sales of these new stores will continue to ramp up steadily. Moreover, we still expect these stores to exceed our targeted internal rate of return for new store investments.

As you’ll recall, we took several merchandizing actions in Q2. We moved slow sellers into clearance faster, we reduced prices for select items and we increased our opportunistic buys. With respect to clearance, our selling of clearance outpaced regular price selling for the quarter as a whole, but we saw sequential improvement in Reg price selling through the quarter, as our team brought in new receipts and injected freshness into the assortment.

In terms of the re-pricing actions we took, we saw accelerated sell-throughs on these key items and we were successful in securing additional opportunistic buys during the quarter that allowed us to increase our value offering particularly in women’s footwear. In short, each of these merchandizing actions worked.

In terms of category performance, accessories was the strongest category with comps in the low teens range, driven by growth in our seasonal and core areas and the expansion of jewelry to all doors. Our men’s and athletic businesses both comped up 2% during the quarter with the latter driven by our fashion athletic category.

While the women’s business comped down 1.6 for the quarter, we saw sequential improvement in the quarter on an overall basis and within Reg price. Our women’s dress business generated strong positive comps while women’s casual continued to show negative comps against double-digit increases in the prior year. We are expanding brands that are doing well within casual while bringing in new silhouettes and testing new resources.

Our casual sandal business had a low-single-digit decline while seasonal sandals actually had an increase but this was offset by weakness in young attitude. We believe this reflects some demand shifting into other young categories. So to summarize our performance in women’s footwear, we’re encouraged by the progress we’ve seen but we still have much more to do before we declare mission accomplished.

We’ve been carrying kid’s footwear online for the past three years. Our research last year identified this as an opportunity area. As a result, we’re testing an assortment of kid’s product at 20 stores during the fall season. These locations are stores that have extra capacity to carry kid’s products without taking anything else off the floor. We are supporting this initiative with an exciting marketing campaign that appeals to the entire family. We will update you on the results of this test next quarter.

Now I’d like to talk about some important actions we’re taking that give us optimism for improved performance in the back half of the year. First, after rolling out charge-send chain-wide last November, this new capability is receiving increased customer acceptance and utilization. The charge-send program is helping our overall customer conversion rates.

Second, we are upgrading our website this fall which will improve site search, generate stronger SEO results and provide a platform for future personalization. Third, we’ve made it easier for customers to enjoy free shipping in a number of ways and they are responding well to these changes.

Fourth, in partnership with a new creative agency, we’ve developed a new advertising campaign that puts the spotlight on our breathtaking assortment in footwear at compelling price points. We’ve also replaced our media agency to help us optimize our media spend by type. We are also increasing our marketing spend in the back half.

Fifth, we’re working to improve our customer data capture to allow us to communicate with our rewards members even more effectively. Sixth, we’ll be launching our first mobile app later this fall. Seventh, we’re piloting our new assortment planning tool in a handful of categories right now. Assortment planning will allow us to localize our store assortments to better cater to market preferences. We expect to rollout assortment planning to all of our footwear category later this year with benefits to begin in the fall of next year.

Eighth, we’re also testing a number of mechanisms to increase customer engagement in our stores. And as we look to 2015, we have several new capabilities on deck including buy online, pick up in store and buy online ship to store. Many of these new capabilities are the direct result of our omni initiative. I’ve often described omni as a project to conform our business processes to the way the customer now wants to shop. While that’s an accurate statement, it’s also a bit incomplete.

Our omni-channel endeavor is really much more than just a project or an initiative. It’s a fundamental change in how DSW conducts business. It’s causing us to view everything we do through the lens of the customer and that is causing us to expand our traditional definitions of our brand cornerstones of assortment and value and convenience. I tell you this because it’s becoming increasingly difficult to isolate the costs and the benefits of omni from our base business.

At the outset of this year, we estimated the cost of omni in 2014 would be $10 million and we projected that it will be earnings accretive after 2014. We still believe that. However, because of the pervasive impact of omni, we’ve concluded there is no longer utility in isolating the impact the omni and so going forward we are just going to incorporate the impact of omni within our overall earnings guidance.

Let me now update you briefly on our Affiliated Business Group. As Mary already noted, ABG had a solid quarter in terms of comp and total sales performance. In addition, we successfully opened our first Yellow Box store in Miami in July and our second new store in southern California earlier this month. Yellow Box is the top five national brand with a strong following and customer response has been positive. We’re excited about our retail partnership with Yellow Box because it demonstrates new ABG capabilities which can pave the way for future growth. We intend to open up a total of four Yellow Box concept stores this year.

Finally, I want to say a few words about Town Shoes of Canada. On August 7, Town Shoes opened the first two DSW stores in the greater Toronto area. Town built an assortment that offers compelling competitive prices and exciting brands leveraging their local expertise. Customer response has been very positive. These are the only two DSW Canada stores Town will open this year.

In conclusion, in the second quarter we accomplished our goals of aligning inventories with our sales expectations and improving our underlying sales trends. We are encouraged to see healthier sell-through rates for new products that we’ve delivered in the second quarter. We are on track with our omni-channel initiative which is starting to drive greater demand and transaction activity within our DSW segment. In short, we made good progress in the second quarter and I want to thank all of my fellow DSW associates for their hard work.

With that, I’ll turn the call back to the operator to open it up for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question is from Mark Montagna of Avondale Partners. Please go ahead.

Mark Montagna - Avondale Partners

Hi. Thank you. Mike, you’ve gone with the new leadership underneath Debbie for the women’s division. What makes you comfortable that – you just had that change in January, what makes you comfortable that by this fall on such a quick turnaround that that merchandize is accurate and really on par with what the customers are looking for because it’s very quick?

Michael R. MacDonald

We’ll I’ll let Debbie comment on that, Mark, but I think what we tried to describe is that our women’s footwear business is a work-in progress not a complete product. I think we’ll continue to make progress and it will take time. As you know, the lead times in footwear are long and to make big changes in a short period of time just doesn’t happen. But we are pleased with what we see so far and we were particularly pleased with the Reg price positive comp that we showed in July in women’s footwear. Debbie, anything else you want to add?

Deborah L. Ferrée

Yes. Good morning, Mark. What I would tell you is with the change in the organization, number one, I think we have the best talent and the organization in this women’s area, so we put the best people on the most critical part of our business. Number two, we have a renewed focus in really driving the things that are important in that area and that is to make sure that we have the right assortments at good value and going back to some of the basics that we talked about before, making sure that our close-out mix or opportunistic buy mix was appropriate and that we’re always leading with a differentiated assortment of great value for the consumer.

Mark Montagna - Avondale Partners

Okay, I mean certainly it looks like it’s working. And then just as a quick follow up regarding opportunistic buys. Do you see this as a permanently higher level of opportunistic buys? And how do we understand what the impact is in terms of maybe percentage of purchases, are you meaning to staff up in that department for opportunistic buys?

Deborah L. Ferrée

Yes. So I would tell you over the last couple of years, Mark, the opportunistic buys actually dropped below the levels that we felt we really needed for our company. So as I said, we have a renewed focus on getting back to the basic fundamentals of our business and that is having a certain percentage of our buy in opportunistic buys. So renewed focus and working very closely with the brands to be able to make sure that we have a consistent flow of that product into our assortments.

Operator

Our next question is from Taposh Bari of Goldman Sachs. Please go ahead.

Taposh Bari - Goldman Sachs

Hi. Good morning. Debbie, a question for you just how you’re thinking about fashion heading into fall. Any early signs how you’re feeling about the boot season?

Deborah L. Ferrée

So it’s very early to call anything on boots right now. We have just starting delivering boots and I would tell you that with what we’ve delivered on the floor so far, we’re pleased but it’s way, way too early to be able to call that.

Taposh Bari - Goldman Sachs

Okay. And what about some of the other categories like dress and casual?

Deborah L. Ferrée

So just got back from two major shoe shows, as you know, so there was an overwhelming amount of new fresh casual in the marketplace that we believe fits clearly in the core of our core customer. So I was very excited about that and see some great opportunity there. As far as the dress business is concerned, as Mike reported, we’ve turned the corner on that. I want to be cautiously optimistic there but I am encouraged by the customer’s response to fresh new products we put on the floor. I saw enough in the market and in addition to what we do in development on our own to be able to continue the momentum that we’ve seen in dress.

Taposh Bari - Goldman Sachs

Great. And then just a quick follow up on gross margins. Mary, you mentioned a couple of one-time items. Can you just repeat them? What their impact was and what the nature was on the gross margin line?

Mary Meixelsperger

In the second quarter there was about 70 basis points of one-time items in the other margin category and those were comprised of some one-time impairment charges of about $1.3 million pre-tax and then the balance was related to some one-time repair and maintenance charges within our overall occupancy structure.

Taposh Bari - Goldman Sachs

And those were included in that $0.37 adjusted number?

Mary Meixelsperger

Yes.

Taposh Bari - Goldman Sachs

And they won’t repeat going forward?

Mary Meixelsperger

That’s correct. Well, I’d say they won’t repeat – we are always reviewing our store fleets for impairment but I don’t expect to see any additional impairment-related charges this year.

Taposh Bari - Goldman Sachs

Okay. Thanks. I’ll pass it on. Good luck.

Mary Meixelsperger

Thank you.

Operator

Our next question is from Scott Krasik of Buckingham Research Group. Please go ahead.

Scott Krasik - Buckingham Research Group

Hi. Thanks very much. So I know you don’t like to talk a lot about or give a comp quarter-to-date, but at least in terms of your Reg pricing, is there anything that gives you less confidence than what you saw in July?

Michael R. MacDonald

Yes, we really can’t comment on that, Scott.

Scott Krasik - Buckingham Research Group

Okay. In terms of your decision to raise your comp guidance to roughly flat for the year, are you assuming positive comps in each of the next two quarters?

Michael R. MacDonald

Yes, I think the math would say you got to get a positive comp in the fall to offset what’s a 1% to 2% negative comp year-to-date.

Scott Krasik - Buckingham Research Group

But not necessarily in both quarters?

Michael R. MacDonald

Not necessarily. We’re just giving annual guidance.

Scott Krasik - Buckingham Research Group

Okay. And then maybe just talk about the new store productivity, obviously we like to see it better sequentially but it is still below plan. So maybe talk about how you’re thinking about opening stores in the future and some of the pressures on the new stores?

Michael R. MacDonald

Sure. Well, I think first of all what we see a lot of times is that new store performance mirrors the performance of our base business. And when the base business is strong, new stores are really terrific and when base business is weak, we struggle a little bit in new stores. So I think that’s what’s going on and obviously the sequential improvement in the new store performance from Q1 to Q2 really supports that because our base business got a little stronger in Q2. I think the important thing that I tried to emphasize is that we might sign up for an IRR 40% or 50% based on our sales projections because we want the best sales projection in those IRRs because we’re going to buy two. And if we end up achieving a 25% IRR, it will still have been the right thing to do open those stores even if we ultimately fall short of our IRR projection. I’m not suggesting we will, we don’t have enough experience to know that, but I am suggesting that we often times sign up for a much higher – greater return than what our minimum hurdle requirement is. So, look, we got a long way to go on those stores. Our typical pattern is that the ones that start out slow ramp up and the ones that start out strong typically tend to stay strong. And I suspect that pattern will play out again. In terms of new store going forward, we’ve got lots of opportunity to complete our build out of full-sized DSW stores so long as we can see success we’re going to continue to open up those stores and we’ve got the additional opportunity in our small format store expansion program which we haven’t declared rollout for yet but I think we ultimately will. And one thing I will say is that we’ve come to look at our new store performance a little differently to an omni lens and what I mean by that is that it’s not just the sales that are recorded there, it’s the sales that are recorded there plus the sales that are demanded there by the customer but perhaps fulfilled in another location or in our fulfillment center. And I think what we’re learning is we really have to take a holistic view and definition of the sales that are being generated by those new stores because what we see, and that doesn’t even include the impact that our new store in a new market can have on dotcom business, but is generated from those geographies. What we find is it’s a pretty good billboard for the DSW brand and it increases awareness and it typically creates a lift in our dotcom business from customers who live in that vicinity.

Operator

Our next question is from Patrick McKeever of MKM Partners. Please go ahead.

Patrick McKeever - MKM Partners

Thanks. Good morning, everyone. Just a question on the urban market store performance, wondering how those stores are performing particularly the ones in New York and Chicago, San Francisco? And how do urban markets factor into your growth plans as we look into next year?

Michael R. MacDonald

Yes, I don’t know that we’ve ever commented on individual store performance and I’m not really interested in starting that now. As I think about the stores that you’ve mentioned, I can think of a store that’s knocking the cover off the ball, I can think of a store that’s generating slightly better performance in the total company and I think of a store that’s lagging the total company, and really that’s kind of how we manage the businesses on a location-by-location basis. We essentially manage our open buys on a location basis. So I don’t think about urban stores as a group requiring separate strategies or considerations. They’re individual stores and that’s how we treat them.

Patrick McKeever - MKM Partners

Okay, fair enough. And then on the decision to test children’s shoes in I think you said 20 stores, what was behind that? Was it driven by success online or just maybe a little color there? And how big might that be as we kind of look forward here? I mean how many stores might eventually have kid’s shoes if the test is successful?

Michael R. MacDonald

Well, we’ve had kid’s online for two or three years now and our customers like the convenience of that and they like the ability to buy it online and if they have to return it in the store and we like that as well. We’ve gotten a lot of our customers who want kid shoes in our brick and mortar locations and they’ve told us that. And they like the convenience of being able to buy both for themselves and for their family and the way we’re currently set up, that isn’t always possible. And so that’s why we thought – and we had some further research that I don’t want to go into that indicates it would be an opportunity for us if we could make it work. In terms of how big it could be, we probably have half of our stores that we could put kid’s into without changing anything. It’s got the capacity, it’s got the space and we wouldn’t have to do much work at all to fit kid’s in. I think most of the other 200 stores we could figure out a way through creating higher capacity fixturing or rearranging the fixturing to allow us to put kid’s in such that probably in 90% or 95% of our stores we could have a kid’s assortment if the test proves to be successful.

Operator

Our next question is from Seth Sigman of Credit Suisse. Please go ahead.

Seth Sigman - Credit Suisse

Great, thanks. Good morning. A couple of questions on the gross margin and you talked a little bit about some efforts to sharpen the pricing. And over the last few years you’ve obviously enjoyed pretty strong margins and obviously in the short term, there’s a little bit of a give back here as you manage the inventory. But as you take these steps to sharpen the pricing, does that limit your ability to get back and kind of recover – the margins get back to some of the prior levels. I’m just wondering what are some of the steps you’re taking, how you’re working to vendors to ensure margins maybe stable long term or any other offsets that you can speak to?

Michael R. MacDonald

Okay, I’ll take the first part and let Debbie cover how we’re working with the vendors. I think Mary’s comments indicated that we expect a sharper pricing in the back half to create some margin pressure. And so you’re right, we are selectively taking prices down to maintain our pricing advantage versus the competition. As to what that means longer term, I think we got to just wait and see. It’s entirely possible that on the items that we re-price and we take a sharper approach to that we could have better sell-throughs at Reg price and fewer of those styles end up in the clearance racks and we end up margin neutral. That would probably be the best that it could be that we’d be margin neutral. On the other hand, it may well be that we get the same sell-throughs and as a consequence whatever we give up on the initial pricing falls through to the margin line. So we just don’t know yet because we don’t have enough experience and we’re going to find that out as we move through the fall. I think it was hard to determine in the spring what those pricing actions had, what impact they had on our margin results just because there wasn’t that much of it and there was so much other noise going on in terms of our clearance acceleration and that kind of thing. So, I think it’s a story that’s yet to be written and we’ll find that out as times go by. Debbie, do you want to talk about how we deal with our vendor partners?

Deborah L. Ferrée

Sure, Mike. So I would say overall the partnerships that we have with our brands you should really think of it as us developing a win-win relationship with our vendor partners. We have an in-season business management approach and process to deliver sales and profitability. I think there are many different levers that we have to deliver margin outside of just talking about the question you had and we have things such as assort planning which will localize assortments and should deliver improved sales and reduce markdowns. We have private brand which delivers an increased gross margin rate of our average. We have accessories growth which actually margins out considerably higher than our average. Getting women’s back on track which is one of our highest margin businesses that is also another lever. And lastly with the inventory management discipline that we have, I think it allows us to really chase into the business and as you know those last sales that actually you add to the top line are actually the most profitable and the highest margin rate. So I would say those were the levers that we’re looking at.

Mary Meixelsperger

Seth, I would just add a couple things. We also, as we’ve mentioned in terms of our assortment planning initiatives, expect with the localization efforts that we’re making with the rollout of assortment planning, we do expect that long term that will also be helping us in terms of our overall margin rate. And then within our omni initiatives we’re doing some work on optimizing our charge-send algorithms in terms of optimizing the location from which we identify where we should shift the inventory from in order to minimize our markdowns. So, there are some other initiatives that will be helping us on the margin line in terms of offsetting some of that pricing pressure as well.

Seth Sigman - Credit Suisse

Okay, that’s helpful. And I assume it’s been difficult to see some of that just given the sales environment but assuming sales improve as you’ve kind of guided to, we should maybe see some of those margin drivers start to come into play, some of those system initiatives that you mentioned. If I could just follow up on the --

Michael R. MacDonald

Just to be clear on that, I think the comments that Debbie made on private brand and on accessories you’ll see those sooner. AP, assortment planning, we don’t expect to see benefit from that until beginning fall season. We tried to be specific about that in the script. And the charge-send optimization that Mary mentioned, that’s a next year item also, hopefully first half of next year but it’s a next year item just so you can be clear in terms of timing of expectations.

Seth Sigman - Credit Suisse

Perfect. Thank you. If I can just follow up on the SG&A, I think you discussed mid-teens growth in the fall. Can you just elaborate on what’s going on there, remind us what happened a year ago that may be driving some of that?

Michael R. MacDonald

Yes, I think Mary talked about three things. She talked about omni spend on IT which I kind of put in the same bucket and then she talked about an increased spending in marketing for additional media. So those are really the three big drivers that we have going on in the fall season. We spend a little bit less in omni in the first half of the year. We still expect to spend the $10 million, so you’re going to have a little bit more of that in the back half. And so much of omni is related to systems that it requires an intensified investment in IT and obviously assortment planning is part of that. And then in terms of marketing, we think we need to beef up our marketing budgets. We need to shout a little louder to the customer and that’s what we intend to do in the back half.

Seth Sigman - Credit Suisse

Thank you.

Operator

Our next question is from David Mann of Johnson Rice. Please go ahead.

David Mann - Johnson Rice

Yes. Thank you. Nice rebound after that first quarter. I had a quick question or couple of questions big picture-oriented. When you look at what happened in the first half, when you think about your commitment to private label and sort of in the assortments, any concerns that you’ve become too reliant on that and that some of your assortments have – that they’ve become too much duplication within the assortments?

Michael R. MacDonald

Statistically, David, we’ve been gradually increasing our private brand penetrations but it’s all the way up to 12% right now. And what we’ve said is that it will likely never get to be more than 15% and we actually police it on a category-by-category basis such that we never let the penetration in any category exceed 20%. So we’re pretty rigorous about that. Debbie, anything else you want to say?

Deborah L. Ferrée

No. I think that describes it perfectly, Mike.

David Mann - Johnson Rice

And then in terms of the commitments part of the ladies categories, clearly there’s been a lot of weakness that you’re seeing on the casual side. When you think bigger picture about space allocation, have you ever thought about shrinking some of these parts of the businesses that are perhaps a lot weaker rather than continuing to commit inventories to those areas?

Mary Meixelsperger

Sure, David. I would tell you that on a monthly basis, there’s a very rigorous discipline around looking at sales and inventory and making sure that inventory matches demand. So that is a discipline that we’ve always had in place. We will continue to demonstrate that. And we do make sure that we flex inventories based on what the customer demand is calling for.

David Mann - Johnson Rice

Okay. And if I can slide one more in about just curious on the follow up on the marketing. How soon should we start to see the marketing hit whether – what medium or media would you be using for that? And then lastly, will it be a strong call to action within that marketing?

Michael R. MacDonald

Yes. You’ll see the marketing beginning later this week and that will be – I mean it’s going to be a healthy dose of TV and digital marketing. And in terms of call to action, I don’t know what you mean by that. If the call to action means we got to kill our assortment particularly in boots and we’re the place, yes, it’s called action. If you’re talking about a pricing call to action, no. I mean we’re going to reemphasize that we have compelling values every single day not sales price.

Operator

Our next question is from Chris Svezia of Susquehanna Financial Group. Please go ahead.

Christopher Svezia - Susquehanna Financial Group

Good morning, everyone, and thanks for taking my questions. First, just Debbie for you, on the casual end of the business, on casual. Can you maybe just talk about some of the things that the new team and yourself are doing to turn that business around, I know it’s going to take time, but I’m just curious what you’re seeing in the marketplace, what you’re testing in the stores more specifically; comfort, casual, et cetera? Just give us some visibility in and around that category. And then I have a follow-up question.

Deborah L. Ferrée

Sure. So, Chris, I would tell you that as we talked about on the last earnings call, there were many brands that actually sat in that class of casual area that we really relied on for many, many years and I think the assortments became a bit stale and maybe some of the product development from the particular brands didn’t move forward as fast as what the customer said they wanted to see it move toward. So we have adjusted our plans to reflect sales expectations in those brands that we believe deliver product to our target customer. So we pulled back sales in some brands. We have added new brands. We have tested new brands. We’ve taken the results in those tests and we’ve really blown out and expanded many of the brands that actually you and I saw in market last week that are really demonstrating some strong growth in that area. So we believe we’ve taken all the right actions to be able to readjust the assortment and brand architecture to reflect what the customer wants and to drive sales in that business. I was excited about what I saw in market last week.

Christopher Svezia - Susquehanna Financial Group

Okay. But you’re not anticipating the casual category in women’s to comp positively in the fall. It’s really predicated on boots, it’s a different category, but boots primarily casual is more of a 2015 opportunity, is that fair to say?

Deborah L. Ferrée

I wouldn’t really say that. We have placed strong expectations on boots and I think that’s the right thing to do. Some of the results of some of these new casual brands that we’ve tested and rolled out are delivering some nice results. I don’t want to promise you positive comp in either quarter in casual but I will tell you directionally we’re seeing some nice results. And if that continues I would expect that you’d see that trend reverse.

Christopher Svezia - Susquehanna Financial Group

Okay. Last question just on the inventory, I’m just curious how we should think about that and your ability obviously to test and react, but is inventory still going to be something you’re going to keep very, very tight to the vest and chase relevant product? I’m just curious how we should think about that.

Deborah L. Ferrée

Yes. I think we’ve demonstrated in past quarters that when we’re in a chase mode, we actually do very well. So we’re going to plan our inventories conservatively and we’re going to play the chase game. That’s when we deliver sales at stronger margins.

Christopher Svezia - Susquehanna Financial Group

Okay. Thank you very much. All the best.

Operator

Your next question is from Kelly Chen of Telsey Advisory Group. Please go ahead.

Kelly Chen - Telsey Advisory Group

Hi, guys. Congrats on a nice quarter. I just wanted to drill into the new store productivity a little bit more. I know that in the past you guys have tested and done some small market and also small format stores. Could you update us on how many stores in the chain are small format versus small market, how those stores are fairing, what you’re learning in the four wall contribution versus the rest of the chain and just how it plays into your future plans for growth?

Michael R. MacDonald

Sure. Well, I think it was a couple of years ago we talked about small market stores and we really don’t talk about them anymore because they’re big stores in smaller markets. I think we identified 250,000 to 400,000 and they’re just more stores, okay. The ones that we’re focusing on are the ones that are smaller formats, smaller footprint stores. They’re typically 10,000 which is about less than half the size of our full line stores. So, those are the ones we’re working on, those are the ones that we’re testing and trying to get the formula right before we declare a full-scale rollout. We opened up two of those small format stores last fall. We’ve opened up another three this spring and we have two more we plan to open up in the fall. So by the end of this year, we’ll have seven small format stores in operation. And what I’d say about how they’re doing is they’re doing fine. They are coming up a little bit short of our sales projection in terms of recorded sales but when you factor in the other demand in sales from those small format locations, they are doing well against their pro forma and they’re meeting their IRR projection that we set for them. So they’re doing fine. We think there is opportunity to do more than fine going forward and we’re going to be testing new ways of engaging the customer in some of those stores yet this fall season as a way of fine-tuning the store operation. They have by definition smaller choice counts within those four walls just because they’re half the size of our full line store. So it requires a little different service model that’s more reliant upon drawing on inventory that might be located elsewhere, and that’s what we’re going to be testing this fall. I think we’ll ultimately get the small format stores cooking well and we’ll declare it a full scale rollout strategy but we’re not quite there yet.

Kelly Chen - Telsey Advisory Group

Got you. And then a follow up just on the SG&A. Could you quantify how much you’ve spent on omni- channel this quarter? And then also I think you guys mentioned that incentive played a factor. Was that a big part of the reason for the SG&A leverage or are there just main buckets where you see some more leeway of flexibility with spending?

Mary Meixelsperger

The omni-channel spend this quarter was around $2 million and so in terms of looking at the total year, we’re really 30% in the front half and about 70% in the back half. So in terms of overall omni spend, that’s the way it’s laying out. Could you repeat the second half of your question, Kelly?

Kelly Chen - Telsey Advisory Group

I thought you mentioned that incentive comp also played a factor in terms of some of the leverage that you saw. Was that a big part of the leverage or could you just quantify the incentive comp?

Mary Meixelsperger

Yes, it was a significant part of the leverage. It provided a favorable impact in the first half of – I’m not sure on a basis point what it was, but I think in total it was about $6 million.

Kelly Chen - Telsey Advisory Group

Great. Thank you.

Operator

Our next question is from Camilo Lyon of Canaccord Genuity. Please go ahead.

Camilo Lyon - Canaccord Genuity

Thanks. Good morning, everyone. I wanted to get your thoughts on the competitive outlook, how you’re seeing the price value relationship in your stores now that you’ve adjusted some of the pricing? It looks like you’re increasing the opportunistic buys. I’d like to get your thoughts on how you’re viewing the back half relative to what you expect the competitive environment to be?

Mary Meixelsperger

Good morning. As I said, we really have an in-season business management process to deliver our sales and margin. So don’t want to really get into the pricing discussion, but I will tell you that it is our objective and we will deliver strong value on the differentiated assortment to the consumer. So that’s really how I look at it and part of that is to deliver some better values to the floor by increasing the opportunistic buy bucket, but we believe that we can deliver the sales and the margin expectations for the back half.

Camilo Lyon - Canaccord Genuity

Are those opportunistic buys expected to be margin neutral or margin accretive?

Mary Meixelsperger

I haven’t really looked at it like that. I look at that that the opportunistic buys are part of the value proposition that we offer our customer. On some things you take a little bit shorter mark and other things you may take a little bit longer mark, but overall I will say we will deliver our margin expectation.

Camilo Lyon - Canaccord Genuity

Okay. And then I guess as it relates to some of – positively on the dress category which was great to see. Debbie, can you disaggregate what portion of that category that turned positive was more Reg price versus promotionally driven? I’m trying to understand the sustainability of the positivity in dress if we strip out some of the promotional activity that ensued in the category?

Deborah L. Ferrée

Sure. So the first thing I will tell you is that we believe as we talked about in first quarter that dress has started to turn the corner. Will dress as a penetration to the total ever see the levels that it did years ago? No, it won’t. And the reason it won’t is because there is a much more casual lifestyle today. So, we are going to let dress elevate itself to whatever degree the customer says that they will buy it. We’re seeing as far as excitement in the industry. The styles are still pretty simple and we rely on our merchant’s development capabilities to bring freshness to that category through new materials and development and also in colors. So that’s what I would really tell you about dress.

Operator

Our next question is from Jeff Van Sinderen of B. Riley. Please go ahead.

Jeff Van Sinderen - B. Riley & Co.

Good morning. I wondered if you could update us a little bit on athletic and athletic derivative what you’re seeing there? I think you mentioned it’s strong. And then also would it make sense for you to change penetration in that segment maybe on a regional or store basis? And then if you could also touch on the men’s business and I have a follow up.

Deborah L. Ferrée

Okay, let me see if I can get everything you asked and if I miss anything you’ll come back and ask that again. As far as the casual business is concerned, we’re excited about what we’ve seen in the market. We feel that it really does address the needs of our core customer and that’s everything from vulcanized to flats to anything that really lies in that casual space. It could be casual boots, shoes or sandals. So I’m excited about what I saw. I like the approach the market is taking with really addressing comfort. I really call it modern comfort, so I like the direction. I think it fits the needs for our customer, and so I am highly encouraged by the direction the market is taking and we will take advantage of that. As far as the men’s business is concerned, as we stated, we comped up two there. I am still encouraged by the men’s business. We still have upside opportunity in casual. We had a nice increase mid-single-digit comp in dress for Q2. We had a comp increase in casual but when I look to what the opportunities are in casual for DSW overall, men’s and women’s fall into that category and I think there is enough freshness out in the market to where we’ll really be able to maximize that for our customer.

Jeff Van Sinderen - B. Riley & Co.

Okay, great. And then I know it started as a test but maybe you could just touch on the kid’s business a little bit more. I think initially you were maybe a little bit reluctant to put kid’s in some of your stores and I’m just wondering how you think about keeping the environment right for adults when you do add kid’s?

Michael R. MacDonald

Yes, it’s a good question. You’re right, we have expressed concern about that and that’s part of the learning we’ll get from this fall 20-store test and we’re going to listen very closely to what our customer says but more importantly what they do. So if they take advantage of the kid’s shoe selection that we put in those 20 stores, that would probably weigh more heavily on our minds than the anecdotal feedback we get from the customers but we do intend to find out how they think about it and whether they feel like there’s been an ambiance change that’s to the negative side. So it’s a good point you raised.

Operator

Our next question is from Steve Marotta of C.L. King & Associates. Please go ahead.

Steven Marotta - C.L. King & Associates

Good morning, everybody. Mary, was there any delay in SG&A costs from the second quarter into the third quarter? I know that the third quarter is expected to be up. You mentioned the omni-channel as well as marketing, but were any of those expenses delayed or previously budgeted for the second quarter?

Mary Meixelsperger

A very small amount of the omni expenses were pushed out but it was less than $1 million and that was just pure timing in terms of things that just crossed over from one month to another.

Michael R. MacDonald

Yes, we didn’t push it. It’s just the way the work fell.

Steven Marotta - C.L. King & Associates

Okay. The second question is that I have heard that you are testing an outdoor category sort of a separation, either a table or at least a portion of the store to outdoor and rugged outdoor. Can you talk about if that’s accurate, first of all? And secondly, how many stores that’s in and what do you anticipate that doing through fall and into spring next year?

Deborah L. Ferrée

Yes, so that isn’t an accurate statement. We’re not testing any outdoor product. Two years ago, we started testing some outdoor brands in some of the markets that required that they needed to deliver a little bit more of that product but it’s not a call-out and strategy. If there’s something outdoor related that we feel is appropriate for a particular store, we’ll buy it as part of the assortment but there is not a test going on in that category.

Steven Marotta - C.L. King & Associates

Great. Thank you very much.

Deborah L. Ferrée

You’re welcome.

Operator

Our next question is from Sam Poser of Sterne Agee. Please go ahead.

Sam Poser - Sterne Agee

Good morning. Thank you for taking my question. In the casual business, can you talk about what role sort of comfort footwear is playing in that, Debbie?

Deborah L. Ferrée

Yes. Good morning, Sam. So as we saw at the last two shoe shows, I think comfort has infiltrated every single category. The vendors, smart-fully so, are putting it into dress, sandals, casual shoes. It is pervasive across the industry and frankly that’s what gets me really excited because customers have been asking for it for a long time and I think they’re doing it in a smart way and there are a couple of brands that actually I think are doing it in an exceptional way. So I think that’s what really is going to continue to drive this casual business and reinvigorate that category.

Operator

This concludes our question-and-answer session. I’d like to turn the conference back over for any closing remarks.

Michael R. MacDonald

Sure. Thanks very much. Listen, we want to thank you all for your continuing interest in DSW and your support. We’re focused on improving near-term results while continuing to manage the business with a long-term mindset. I know if you have follow-up questions, Mary and Christina are going to be available during the day so feel free to contact them. Thanks, again.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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