Earnings Call Transcript - SHOO Q3 2020

Operator, Operator

Thank you for joining us for the Q3 2020 Steven Madden Limited Earnings Conference Call. I will now turn the call over to Danielle McCoy, our Director of Corporate Development and Investor Relations. Please proceed, Danielle.

Danielle McCoy, Director of Corporate Development and Investor Relations

Thanks, Susan, and good morning, everyone. Thank you for joining our third quarter 2020 earnings call and webcast. Before we begin, I'd like to remind you that during our call, we may make certain forward-looking statements as defined in the federal securities laws regarding our expectations or predictions about the future. Generally, these statements relate to projections involving anticipated revenues, earnings or other aspects of the company's operating results. Because these statements are based on current assumptions and expectations, they involve known and unknown risks, uncertainties and factors not within the company's control. And as such, our actual performance and results may differ materially from these statements. Our annual report and other reports filed with the SEC from time to time include detailed discussions of the risk the company faces, and we urge you to refer to these. Specifically, the COVID-19 pandemic has had and is currently having a significant impact on the company's business operations and results. Such forward-looking statements with respect to the COVID-19 pandemic include, without limitation, statements with respect to the company's plans in response to this pandemic. At this time, there is significant uncertainty about the duration and extent of the impact of the COVID-19 pandemic. Due to the dynamic nature of these circumstances, statements made on this call regarding the company's response to the COVID-19 pandemic could change at any time. Any forward-looking statements represent our judgment as of the time of this call and cannot be relied upon as current after today's date. We disclaim any intent or obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required under applicable law. The financial results discussed are on an adjusted basis, unless otherwise noted. A reconciliation to the most directly comparable GAAP financial measure and other associated disclosures are contained in our earnings release. Joining the call today is Ed Rosenfeld, the Chairman and CEO of Steve Madden. With that, I'll turn it over to Ed. Ed?

Ed Rosenfeld, Chairman and CEO

Thanks, Danielle. Good morning, everyone, and thank you for being here to discuss Steve Madden's third quarter 2020 results. Although the COVID-19 pandemic continues to negatively affect our business, I'm encouraged by the progress we made in the third quarter, achieving revenue and earnings that greatly surpassed our expectations and advancing initiatives that position the company to capture market share and foster profitable growth in the future. At Steve Madden, product is our primary focus. Steve and our design teams excel at quickly identifying new trends, creating products that align with those trends, and getting them to market ahead of competitors. During this time of rapidly changing consumer preferences, we have relied on our effective test and react model and industry-leading speed to market capabilities to swiftly adjust our merchandise assortments to meet customer demands, expanding on growing categories like slippers and slides while scaling back down-trending categories like dress shoes. We have also made significant strides in advancing our digital commerce growth agenda, increasing our investments in talent, digital marketing, and new e-commerce and omnichannel initiatives, which are crucial for sustained growth in this important channel. While we have invested in digital, we have also sought ways to streamline and reduce expenses in other areas of the company, including the tough decision to terminate about 250 corporate employees in the third quarter, which will result in annual savings of around $25 million. Finally, we have acted quickly to manage our inventories and address the surplus stock created by COVID-19 store closures and order cancellations. Currently, our inventories align with sales trends, and we have managed to dispose of or have orders for more than 95% of the excess inventory from the COVID-19 disruptions, putting us in a strong position as we move forward. We are confident that these actions, along with our strong brands, excellent balance sheet, and proven business model, will enable us to navigate this crisis and thrive once conditions normalize. Now let’s review our results for the quarter. Consolidated revenue fell 31% and diluted EPS was down 42% compared to last year's third quarter. Obviously, these numbers aren't typical for Steve Madden, and we do not plan to become accustomed to them. However, given the circumstances, we are satisfied with our performance for the quarter, as results surpassed our forecast both on the top and bottom lines. In wholesale footwear, revenue dropped 32%, compared to our expectation of a 35% decline. Our core Steve Madden Women's Division saw a mid-teens percentage decline, which was significantly better than we anticipated due to strong early demand for boots, particularly lug bottom styles, and accelerated boot shipments to key wholesale clients in September. Our Steve Madden Europe business also outperformed in the quarter, with revenue up from last year, fueled by robust sales through e-commerce partners like Zalando and ASOS. In wholesale accessories and apparel, revenue went down 33%, better than our forecast of a 40% decrease. We were pleasantly surprised by the strength in the handbag category, both branded and private label, which exceeded our expectations, with private label recording year-over-year sales growth in Q3, driven by gains in the mass channel. Apparel also contributed positively to our performance, with the co-branded BB Dakota Steve Madden line hitting stores and websites in August, including major retailers like Nordstrom, REVOLVE, Bloomingdale's, Shopbop, and of course, stevemadden.com. We have seen strong initial sales, particularly in dresses and sweaters. Looking forward, while our wholesale business will remain pressured by the pandemic's impact, we expect to see sequential improvement in Q4 compared to Q3, mainly due to ongoing recovery in our flagship Steve Madden brand in both footwear and handbags. We anticipate fourth quarter wholesale revenue to decline by high teens percentage-wise compared to the same period last year. In our retail segment, revenue fell 22%, better than our expectation of a 25% drop. Our e-commerce operations, especially on stevemadden.com, continue to shine, with revenue increasing by 82% for the quarter, following a 72% increase in last year's third quarter. This marks our second straight quarter of over 80% year-over-year growth in that segment. We continue to achieve strong returns on our increased investment in digital marketing and positive consumer response to new initiatives like try before you buy. Regarding our brick-and-mortar operations, we began the quarter with just over 50% of our U.S. stores open. Although we reopened nearly all remaining stores in July, we were forced to close 14 stores in California from mid-July to the end of September due to renewed government restrictions. Outside the U.S., our stores remained open throughout the quarter, except for two in Mexico that reopened in August and 21 in Israel that had to close again in September due to renewed lockdowns. On average, store hours have been reduced by 25% to 30%. We plan to extend operating hours at most of our stores starting in November. Traffic and sales in reopened stores have shown some improvement over the last two months, though the store business continues to face considerable pressure. Looking ahead, we expect fourth quarter retail segment revenue to decline in the high teens percentage-wise compared to the previous year. Overall, our operating margin for the quarter was 13.3%, compared to 14.4% for the same period last year. Consolidated gross margin increased by 130 basis points, driven by our e-commerce business, which had higher margins and accounted for a larger portion of our total mix compared to the prior year. As expected, operating expenses increased relative to last year due to reduced revenue, but we mitigated the impact through cost-cutting measures that reduced operating expenses by 24% compared to the previous year. Looking ahead, we predict fourth quarter operating expenses to decline by approximately 10% compared to the prior year. Overall, we are pleased with our performance in a challenging quarter. As we move forward, we acknowledge the ongoing challenges we will face in the near term, but we are also optimistic about the opportunities that lie ahead. With our strong brands, effective business model, stable financial foundation, and especially our exceptionally talented and dedicated employees, we are well positioned to seize market share opportunities and promote sustainable growth in the coming years. Now I'll hand it over to Danielle to discuss our financial performance in more detail for the quarter.

Danielle McCoy, Director of Corporate Development and Investor Relations

Thanks, Ed. Given the challenging retail landscape, we were pleased with our third quarter results that came in significantly ahead of our expectations. In the third quarter, our total revenue decreased 30.9% to $346.9 million compared to prior year total revenue of $502.1 million. Our wholesale segment declined 32.7% to $283.8 million compared to $421.6 million in the prior year period, including a decline in wholesale footwear of 32.5% to $213.3 million and a decline in wholesale accessories and apparel of 33.3% to $70.5 million. In our retail segment, revenue decreased 22.1% to $59 million as our brick-and-mortar business remained under significant pressure during the quarter. In our e-commerce business, performance remained strong despite the reopening of our stores. Digital sales rose 63.3% in the quarter, including 81.8% growth on stevemadden.com. We ended the quarter with 221 company-operated retail stores, including 67 outlets and 8 e-commerce stores, as well as 17 company-operated concessions in international markets. Turning to our Licensing and First Cost segments. Our Licensing royalty income, which is now included in total revenue, was $2.6 million in the quarter compared to $2.9 million in last year's third quarter. First Cost commission income, which is also now included in total revenue, was $1.5 million in the third quarter of 2020 compared to $1.9 million last year. Consolidated gross margin in the quarter increased 130 basis points to 40.3% compared to 39% in the prior year period. Wholesale gross margin rose 70 basis points to 34.6% compared to 33.9% last year, driven by an increase in wholesale accessories and apparel. Retail gross margin rose 50 basis points to 63.8% compared to 63.3% in 2019 due to stronger margin in e-commerce. Operating expenses for the quarter decreased 24.2% to $93.7 million compared to $123.6 million in the prior year's third quarter, reflecting the actions taken to reduce payroll and scale back on nonessential operating expenses. Operating income for the quarter totaled $46.2 million, compared to last year's third quarter operating income of $72.3 million. Our effective tax rate for the quarter was 29.3%, compared to 22.6% in the same period last year. Finally, net income attributable to Steve Madden Limited for the quarter was $31.8 million or $0.39 per diluted share compared to net income of $56 million or $0.67 per diluted share in the third quarter of 2019. Moving to the balance sheet, our financial foundation remains strong. As of September 30, 2020, we had $257.2 million of cash, cash equivalents, and short-term investments and no debt. Inventory totaled $109.7 million, down 25.9% compared to the prior year figure of $148.1 million. CapEx in the quarter was $1.2 million. Last, given the significant uncertainty related to the COVID-19 pandemic, we are not providing earnings guidance at this time. Now I'd like to turn it over to the operator for questions.

Operator, Operator

Our first question comes from the line of Paul Lejuez from Citi.

Paul Lejuez, Analyst

Curious if you can maybe talk a little bit about how you're planning the first half of '21, maybe speak to what your order book looks like this time? And just from talking to your wholesale partners, are they holding off pricing orders to a later date? And then also kind of related to that, can you maybe talk a little bit about your private label business performance in the mass channel? What that might look like as a percent of total as you think about F '21 versus where you were, let's say, in F '19?

Ed Rosenfeld, Chairman and CEO

In terms of how wholesale customers are approaching spring, they seem to be adopting a conservative stance. Most are planning their business down roughly 15% to 20% compared to 2019 or what their plans looked like for 2020 at this time last year. We are not ready to specify our projections just yet, but these are the trends we are seeing from wholesale partners. Regarding private label, we feel fortunate to have a significant business with major mass merchants, nearing $300 million combined. We are having productive discussions with them about new initiatives, and we expect this segment to grow for us in 2021. I anticipate it will represent a larger portion of our overall mix next year.

Paul Lejuez, Analyst

Got it. Just one follow-up. Can you maybe talk a little bit about what you're seeing from an e-comm perspective just in terms of the average order size online during this period versus, let's say, last year, average order size, UPT return rates? Maybe if you can just speak to what you're seeing on that direct business?

Ed Rosenfeld, Chairman and CEO

Sure. Yes. Well, certainly, over this summer, we saw a decline in the AUR. We were more promotional on our own website than we were a year ago as we were utilizing that channel to clear through some of the excess inventory created by all the COVID-19 disruption. We're also selling some lower AUR items like masks. But as we come into fall here, we're seeing that AUR creep back up. And I think going forward, it should be more in line with what we've seen historically. In terms of UPT on the other hand, that was up over the summer, and that was helping us to counteract some of the decrease in the AUR. We've talked about the success we've had with our installment payment program, which we modified over the summer to add this try before you buy concept. We've noted that this drives a significant percentage of our checkout now, and on those orders, we see a very nice lift in the average order value compared to the balance of our orders. So that's also helping to drive average order value up.

Paul Lejuez, Analyst

Anything on return rates, Ed?

Ed Rosenfeld, Chairman and CEO

I'm sorry. Yes, return rates have not moved significantly from where they've been historically.

Operator, Operator

Next question comes from the line of Camilo Lyon from BTIG.

Camilo Lyon, Analyst

Ed, in the past, you mentioned the disparity between full price wholesale partners and the off-price channel. Can you talk about if that disparity in that gap is still present? And when do you anticipate that gap from an ordering perspective to close?

Ed Rosenfeld, Chairman and CEO

Yes. Good question. In Q3, we noticed that our sales to full price accounts performed significantly better than our sales to the off-price channel. This refers to our shipments, not our sell-through. We expect to see improvements in Q4, and I believe the channels will become more aligned moving forward.

Camilo Lyon, Analyst

That's great. I think it's important to discuss the market share comments you've been making. Given your newness and the products you've been launching, have you started to notice any changes in your order patterns? Or is it still too early to determine if this is reflected in at-once orders, reorders, or spring orders?

Ed Rosenfeld, Chairman and CEO

Yes. No. I mean, look, we've got some strong selling products and we're seeing the retailers react to it, and we've certainly chased into some items here for fourth quarter, particularly in the boot category. I mentioned, I think, the lug boots in the prepared remarks, and those are doing great for us. So yes, we are starting to see the retailers react to that.

Camilo Lyon, Analyst

Great. And just the last one for me is on gross margin. You didn't give any color on where you thought Q4 gross margins would shake out. But just judging by the last 2 quarters, margins have been up about 130 basis points. And with Q4 being a bigger DTC quarter, it's safe to say that, that's at least where we should shake out for Q4 margins?

Ed Rosenfeld, Chairman and CEO

I believe we can expect some improvement in year-over-year gross margins. While you mentioned the DTC issue, it's also important to note that our inventories are well managed. They were down 26% at the end of Q3, and we've projected revenue declines in the high teens for both wholesale and retail. Therefore, with our inventories under control, I anticipate we will achieve a bit of gross margin improvement in Q4.

Operator, Operator

Our next question comes from the line of Erinn Murphy from Piper Sandler.

Ed Rosenfeld, Chairman and CEO

Operator, can we move on and come back to her?

Operator, Operator

That is noted. Next question comes from the line of Janine Stichter from Jefferies.

Janine Stichter, Analyst

I know you touched a bit on AUR trends for the e-commerce business. Just wanted to ask about broader AUR trends. You mentioned some puts and takes in terms of products with some of the boots performing well, but then also, I think, slippers and slides trending. So are there any implications for how we should think about AUR just from product mix in the fourth quarter?

Ed Rosenfeld, Chairman and CEO

Yes, you pointed out correctly that we have slippers, which made up only about 1% of the women's mix in last year's fourth quarter, and that's expected to increase to around 9% this year. While these are lower-priced items, the proportion of boots and booties is also rising, from about 44% last year to approximately 50% this year. However, the overall impact is relatively modest, and I don't anticipate a significant change in average unit retail in the fourth quarter.

Janine Stichter, Analyst

Great. And then just a follow-up on gross margin. I think you mentioned that e-commerce gross margin was better. Was that just a function of you were shipping more from the warehouse? Was there anything like that going on? Or anything in terms of promotional levels that drove that?

Ed Rosenfeld, Chairman and CEO

E-commerce typically outperforms physical stores, and we are not being overly promotional online. While we were a bit more promotional early this summer compared to the previous year, we have reduced that as we moved through the third quarter and into the fourth quarter. Even towards the end of the third quarter, we had some promotional messaging related to our clearance items, but this represented a small portion of our total online offerings, and we were still achieving a significant amount of full-price sales.

Operator, Operator

Our next question comes from the line of Matthew Degulis from KeyBanc Capital Markets.

Matthew Degulis, Analyst

I'm curious about how the growth of e-commerce will interact with wholesale, possibly in the upcoming year. With the expansion of your owned e-commerce and your previous use of it to test products, I'm wondering if offering higher-end test products online could attract more attention and potentially lead to larger initial inventory orders from wholesalers, allowing you to secure more shelf space from them in the future.

Ed Rosenfeld, Chairman and CEO

I'm sorry, you were cutting out at the beginning of that question. Could you please repeat that?

Matthew Degulis, Analyst

Yes. So I just know you guys test online. And now with your e-commerce growing so quickly, you get more eyeballs on your test product. I'm wondering how that maybe helps your case with your wholesale customers moving forward and maybe helps you take shelf space next year?

Ed Rosenfeld, Chairman and CEO

Yes, it's an interesting question. Look, I think that we had a plenty big enough sample size on our test products, whether we were testing it in stores or online, even previous to what we're seeing now. So I honestly don't think that, that makes any significant difference.

Matthew Degulis, Analyst

Got it. Okay. And one separate question. You mentioned lug boots a bit, but can you comment a bit more on the overall boots and booties category this winter? How maybe the higher AUR will flow through the revenue and gross margin? I ask because I think the case can be made that people want to spend a lot of time outside when it's slushy this winter, which could provide a nice tailwind to a brand like Blondo, but I'd like to hear your thoughts.

Ed Rosenfeld, Chairman and CEO

We're seeing positive trends in the boot category. We were pleasantly surprised by early sales. Initially, we thought spring and summer products would sell later in the season, but boots started to sell well earlier. As mentioned, we managed to adjust our shipments to bring in more boot products for Q3 and continue that momentum into Q4. The lug styles are particularly interesting because they're casual and comfortable, aligning with current trends. Overall, this is contributing to a greater share within our business, which we have factored into our sales forecast.

Operator, Operator

Our next question comes from the line of Sam Poser from Susquehanna.

Will Gaertner, Analyst

Ed Rosenfeld: Sure. Yes. You mentioned some of the challenging areas. In terms of our overall performance, Steve Madden Women's is outperforming the business as a whole. Kids are also doing well. However, Men's is facing challenges. We're observing the same trends as many others who are not large athletic brands, particularly in the dress and dress casual segments of the men's market, which are currently struggling. We are actively modifying our merchandise assortment to emphasize more casual products and include additional slides and slippers. Anne Klein also faces challenges due to its historical focus on career and dress items, but the team has successfully introduced some appealing new casual styles. I’m optimistic about improvements in that segment for spring. I feel positive about Madden Girl's performance in terms of sell-through during the spring/summer period. They have maintained a strong presence in the footbed category over the past few years, which is evident in the current market dynamics influenced by COVID-19. Their offerings in boots, including lug and combat styles, are performing well. That essentially summarizes our position.

Operator, Operator

Our next question comes from the line of Jay Sole from UBS.

Jay Sole, Analyst

Ed, can you talk about what you're seeing from your customers in terms of if the trends you're seeing are due to the stay-at-home trend or more to the casual trend, or is it just sort of an economic thing where obviously, there's somewhat of a recessionary environment out there. Can you sort of talk about what you think the biggest driver is?

Ed Rosenfeld, Chairman and CEO

In terms of product trends, I definitely think that the stay-at-home, work-from-home, casualization is a very big driver of what we're seeing now and probably the most significant factor.

Jay Sole, Analyst

What indicators are you looking at to anticipate what next year will be like? Do you believe people want to return to the workplace? Have you conducted any research on this, or do you have any insights on how consumers may react next year?

Ed Rosenfeld, Chairman and CEO

Are you talking about in terms of what products would be good or what the numbers will look like?

Jay Sole, Analyst

No, just in terms of like stay-at-home, are people going to continue to want to stay at home and wear casual? Or do you think we'll see a reversal back to some of the more traditional dress, footwear styles?

Ed Rosenfeld, Chairman and CEO

What we do is listen to the customer. We are always testing new products and pursuing those that elicit a positive response. I am not inclined to make any predictions about the future. The biggest factor will be the outcome of the virus situation. I believe that once the virus is under control, there will likely be pent-up demand from people eager to go out and possibly wear dress shoes. However, I cannot provide any more insight into when that might occur than you can.

Jay Sole, Analyst

Can you elaborate a little bit on some of the accelerated investments you're making in e-commerce and digital, including where you're focused and what the goals are?

Ed Rosenfeld, Chairman and CEO

Yes. Well, look, we're pulling back on expenses throughout the business, but not in that area, in that area we're really investing. I think it starts with talent in the organization. And we've brought on some very high-level talent that we're very excited about over the last couple of months. We talked about the digital marketing investments that we're making. Our digital marketing spend is up dramatically this year versus last year, and we're getting returns on that, whether that's across all the normal channels, paid social, email, text, influencer, paid search, et cetera. We also just launched a new app about a month ago, which we're excited about. We're rolling out a lot of new initiatives. I mentioned, try before you buy. I'm also excited, I think, longer term, about the enhanced delivery options. You may recall that a couple of years ago when we introduced free 2-day shipping, that really was very successful for us, and we want to up the ante even further. Earlier this year, we started testing free 1-day shipping and same-day delivery. Obviously, we offer that where we can do it cost-effectively, where we have stores that can facilitate the delivery there. That's in a handful of stores now, I think about 17 stores, and we'll roll that out to the balance of the chain going forward. There are a whole bunch of other initiatives that we're working on that we're not ready to unveil yet. But it's certainly the #1 focus area for our company, and we're excited about the momentum that we have there.

Jay Sole, Analyst

It sounds great. If I can actually sneak one more in. Just if you could clarify your comments on handbags a little bit. Was it just really in the mass channel where you saw the surprising strength? Or was it sort of across all your channels? And is the guidance for high teens, down high teens, Q4 sales, does that apply to the wholesale accessories business as well?

Ed Rosenfeld, Chairman and CEO

Yes. So we're actually also pleasantly surprised about what we're seeing in the branded side. Particularly in what we're looking at in terms of our orders for Q4, we've seen a really nice recovery in our branded handbag business, particularly the Steve Madden brand. In terms of that down high teens forecast for Q4 in wholesale, I actually think, in this case, wholesale accessories and apparel will actually be better than that. So wholesale accessories and apparel should even be a little bit better than wholesale footwear in Q4.

Operator, Operator

The next question comes from the line of Laura Champine from Loop Capital.

Laura Champine, Analyst

It's really a follow-up on what you just said, Ed. So with a lot of retailers obviously trying to move the holiday season earlier for a variety of reasons this year, do you actually have better visibility into Q4 trends than you normally would at the end of October?

Ed Rosenfeld, Chairman and CEO

I don't know I would say that. Yes, I think we do obviously anticipate or are aware that everybody is going to try to start their promotions really, I think, for the whole month of November this year and try to elongate the holiday season, but I can't say that we have better visibility. And certainly, if you think about surging COVID-19 cases recently and the uncertainty that that creates, I still think it's a pretty volatile and uncertain environment.

Operator, Operator

Next question comes from the line of Dana Telsey from Telsey Advisory.

Dana Telsey, Analyst

It’s Dana. As you think about fulfillment and the fulfillment options, what are you thinking and how you're planning on shipping and surcharges that are expected, whether it's the holiday season or go forward? And then I have a follow-up.

Ed Rosenfeld, Chairman and CEO

Sure. Yes. Well, so historically, with our e-commerce business, we've actually fulfilled the majority of our orders from our stores. This year, we've done a lot more out of the warehouse. Given the COVID-19 disruption, we would like to swing some of that back to the stores, but it's a bit of a moving target. One thing that we did have to suspend, which I probably should have mentioned earlier when I alluded to free 2-day shipping, was that we have suspended free 2-day shipping this year, and that originally was due to some of the disruption. Now it's really primarily due to the fact that the shipping carriers are not willing to commit to their normal levels of service given the overwhelming demand that they have right now. We look forward to being able to get back to that early next year. You mentioned the surcharges, obviously, we're aware of that issue and have baked that into our internal forecast here for Q4. The good news is we do have some contractual protection in our contracts with them that caps how much we can get hurt by that, but certainly, it will impact us.

Dana Telsey, Analyst

Got it. And then as you think about the e-commerce margins given the strength there, are e-commerce margins accelerating as you're scaling the e-commerce business? And is there any penetration rate that you're looking at as we hopefully get to the other side sometime next year, is what percent of the business should be e-commerce as a result of this?

Ed Rosenfeld, Chairman and CEO

Yes. We continue to see profit margins increase in e-commerce. Over the last few years, we've driven this very strong sales growth, but each year, the growth in profitability has been in excess of the growth in top line as we continue to drive that profit margin up. So we're pleased about that. We still think we have some potential for continued improvement in the profit contribution margins from e-commerce. In terms of where I think the penetration will be, look, if we're putting the whole thing together, wholesale and retail, we were at about 20% in 2019 e-commerce. This year, it's going to be close to double that. I don't know exactly where we'll come in, but it's up dramatically. At some point, we're going to probably see 50%.

Dana Telsey, Analyst

Got it. And are there other expense benefits that you're benefiting from, like lease renegotiations? And are you seeing outlet versus full-line stores as typically outlets done a little bit better for you. What are you seeing there?

Ed Rosenfeld, Chairman and CEO

Sure. In terms of the lease negotiations, yes, we've reached agreement with a number of our landlords and we've taken kind of a custom approach based on the lease. We've done a few different things. In some cases, we've restructured the leases. In essence, buying out of the current obligation and replacing it with a percentage rent structure going forward. We've also gotten current period abatements. We also bought out some leases outright. We've done a handful of things, but a number of those negotiations remain ongoing. We're continuing to work with our landlord partners on that. In terms of outlets versus full line stores, yes, outlets continue to perform better than full line stores. That's not surprising that people are more comfortable going to what are primarily outdoor centers compared to enclosed malls. On average, outlets have been, I don't know, 1,000 basis points better than full-price stores or even more, maybe more like 1,200 basis points better.

Operator, Operator

Next question comes from the line of Susan Anderson from B. Riley Securities.

Susan Anderson, Analyst

I'm curious if you could talk about the usage of Afterpay on your website and I guess, what percent of sales is coming from Afterpay? And if you could maybe talk about conversion and basket size there, if that helps with that?

Ed Rosenfeld, Chairman and CEO

Well, I know I can't give you the actual number, but I think we've been pretty clear that it's a very significant percentage of checkout, and they were getting a very significant lift in the AOV on those items. I don't think I can get any more granular than that.

Susan Anderson, Analyst

Okay. And then also, I was wondering if you had an update on China sourcing exposures, potentially we could get some sort of change there with the election?

Ed Rosenfeld, Chairman and CEO

Yes. As you know, we have been working hard to move production out of China since spring. If you look solely at our landed goods, excluding the First Cost business, we were in the low 60s coming from China, down from the 90s a couple of years ago. We've mentioned in previous calls that for the fall, we actually paused that effort to continue moving out of China because, due to the COVID-19 situation, especially early on with the disruptions in China, it has been the most dependable location for us. We felt most assured that we could secure goods for fall from there, given the situation in many other countries we source from. Most of our products for fall are still being sourced from China. However, for spring, you will notice that we will start to diversify away from China again, including sourcing from countries like Mexico, Cambodia, Brazil, and Vietnam.

Susan Anderson, Analyst

Great. And then I guess, lastly, as we look out to next year and maybe even the back half of next year, how are you thinking about the mix of casual, which I know you've worked hard to mix more into. But I guess, at what point in time do you think you'll think about kind of reversing that and going back into fashion?

Ed Rosenfeld, Chairman and CEO

We will let our customers determine the product mix. This has always been our approach. We test and adapt based on customer preferences. I want to emphasize that casual is still fashion. Although we have casual and dress shoes, our customers are looking for fashionable options, even in more casual styles. A noteworthy trend in our business is the strong performance of novelty products and eye-catching styles that were once considered niche but are now among our best sellers. Customers are drawn to products with bold embellishments and ornamentation, whether it's a slipper, slide, or sneaker. They desire products with emotional appeal, which also tend to stand out online. Ultimately, even for casual items, we maintain a fashion-forward perspective.

Operator, Operator

Next question comes from the line of Tom Nikic from Wells Fargo.

Tom Nikic, Analyst

I wanted to ask about the cost structure of the business. So I know, Ed, you have the $25 million that you're saving from the headcount reduction that you did in Q3. Are there any other cost saves when we kind of think about, I guess, the sort of more normalized OpEx structure of the business? Should we think that store operating hours will sort of be less than they were pre-COVID? Are there any other cost saves that we should think about as we model in 2021 and beyond?

Ed Rosenfeld, Chairman and CEO

Well, I alluded to the negotiations with the landlords, and we have made significant progress there. We have been able to restructure a number of leases. We've gotten out of some bad leases. We will have significant savings in '21 and beyond compared to where we were prior. Given that we have a couple of the big conversations ongoing there. I'd prefer to wait to quantify that until we resolve those. That's a significant number as well. We're taking a hard look at every expense line item. A lot of the discretionary expenses that we took out this year, I think we'll be able to continue to see savings in those buckets going forward. We're going to continue to really control it. Again, we were down 24% in Q3. We said we think we'll be down about 10% in Q4.

Operator, Operator

Next question comes from the line of Chris Svezia from Wedbush.

Chris Svezia, Analyst

Nice job on the quarter. I have a couple of things. I guess, number one, just go back to the gross margin on wholesale footwear and accessories, the improvement. You mentioned that it was driven largely by the accessories and apparel piece. Maybe unpack a little bit of color about what happened on footwear? I think you were going to be selling a lot of the product you took reserves for earlier in the year. Just maybe unpack maybe where that footwear wholesale margins stand at this point? And do they really start to accelerate in Q4 and beyond? Or is there still more pressure there?

Ed Rosenfeld, Chairman and CEO

Yes. So wholesale footwear was down about 100 basis points in Q3, and that was better than we had anticipated. We were clearing through a lot of that COVID-19 inventory. We did better than we anticipated that we would on the clearance of that. The teams did a great job, and we got a better recovery from the folks that we sold it to than we thought we would. We also worked with our factory partners to get some concessions on that end. Overall, we did not take the hit that we expected on clearing that merchandise. Some of that is going to go out in Q4 as well. I think that margins in wholesale footwear could be flat to even modestly up in Q4.

Chris Svezia, Analyst

Okay. That's helpful. I want to revisit your earlier comment in the Q&A. When analyzing the marketplace for the first half of 2021, you mentioned that the industry is down 15% to 20%. Are you referring to all channels, including in-line and mass, or just the in-line channels?

Ed Rosenfeld, Chairman and CEO

That's really the branded channels. I think the mass channel should be considerably better than that.

Chris Svezia, Analyst

I'm curious about the off-price channels. Where do they currently stand? It seems there may be inventory packaway product or a shift into other categories. Are we beginning to see improvement in the first half, or is that still a challenging area? I know that typically presents a good opportunity for profitability, so I'm interested in your perspective on that, considering the downtrend of 15% to 20%.

Ed Rosenfeld, Chairman and CEO

I'm glad you asked that question because I realized I neglected to talk about spring when I addressed the off-price versus full price question earlier. We have seen off-price improve and come back for Q4 after trailing full price by a significant margin in Q3. It's better than we anticipated for spring of '21. However, there is a considerable amount of pack and hold inventory of spring/summer products that were sold to that segment, which they will be able to release for spring of '21. This will definitely impact their willingness to purchase upfront, and it's something for us to keep in mind as we look at spring '21.

Chris Svezia, Analyst

Okay. That's helpful. And just on the reminders we get on private label, that seems to be the growth engine for you guys, doing really well there. From a profit perspective, maybe how we think about that relative to the core in-line or even the off-price business, is that in line? Is it slightly less? Just sort of where does that fall in the mix?

Ed Rosenfeld, Chairman and CEO

Reminding that gross margins are considerably lower in that business. It also has a lower operating expense structure. But even so, the operating margins are lower there. It's a nice business because we do it with no inventory risk or investment because we do it on a first cost basis primarily, but the operating margins are lower.

Chris Svezia, Analyst

Okay. One last thing from me. When you consider your stores, and I believe you mentioned that, in total, both digital and retail are down in the high teens, how should we view the stores and the possibility of additional closures as we approach the fourth quarter during the holiday season? Are you assuming it will stay about the same? Or do you anticipate changes? How are you approaching this in terms of potential fluctuations?

Ed Rosenfeld, Chairman and CEO

Well, we certainly have not factored in any improvement from where we are today. I think we could even soften a little bit and hit that number.

Operator, Operator

Next question comes from the line of Erinn Murphy from Piper Sandler.

Erinn Murphy, Analyst

I guess I had a follow-up, Ed, for you, just on one of the earlier questions around shipping surcharges. Are you seeing any pressure build in terms of ocean freight or anything that's starting to bubble up at the ports at this point just given people trying to get ahead of the holiday season?

Ed Rosenfeld, Chairman and CEO

Yes. There are two main issues to address. First, we've been experiencing delays throughout the supply chain, which is affecting not just us but many others as well. We're dealing with limited supply and challenges in obtaining containers and vessels, which has slowed operations overseas. Additionally, there has been some port congestion. Once the goods arrive at our warehouses and those of our wholesale customers, the process has been further delayed due to labor shortages and other disruptions related to COVID. This situation has likely added a couple of weeks to the time it takes to get shoes from the factory to the store. The second issue is the increase in freight costs. Air freight rates have nearly doubled compared to earlier this year, so we have to be selective about what we send via air. Ocean freight rates have also risen by 25% to 30%.

Erinn Murphy, Analyst

Has consumer traffic slowed down even more as we've entered October, especially with the recent waves affecting parts of the U.S.?

Ed Rosenfeld, Chairman and CEO

At this point, we have not seen a further deceleration, but we have seen stagnation in terms of the improvement. September was considerably better than what we saw in July and August, and October has sort of flat to September.

Erinn Murphy, Analyst

Okay. That's helpful. And then just last question, just going back to private label and just thinking about Target and Walmart in particular, how big do you feel like those businesses could be over time? And is there a way that you're trying to balance them but they're not, I mean, so big but you're seeking to kind of still keep your first market or first tier kind of branded product in the focus?

Ed Rosenfeld, Chairman and CEO

I don't have a forecast for how substantial they can become. However, it is a strength of our company to have a solid position with them, especially since they are currently experiencing growth. These customers are gaining market share across various categories, including shoes, accessories, and apparel. We aim to continue our growth alongside them. Rather than focusing on percentages compared to other areas, our priority is to grow our branded business, whether through digital channels or other means. We certainly will not limit the growth of the mass channels.

Operator, Operator

I'm showing no further questions at this time. I would now like to turn the conference back to Ed Rosenfeld.

Ed Rosenfeld, Chairman and CEO

Okay. Well, great. Well, thanks, everybody, for joining us, and hope you have a great day, and I look forward to speaking with you on the fourth quarter call. Bye-bye.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.