Business Context and Reporting Period
Company: DSW Inc. (DSW), a leading U.S. branded footwear specialty retailer.
Reporting Period: Fiscal year ended January 31, 2009 (52 weeks).
Operations: As of January 31, 2009, DSW operated 298 stores in 37 states, 377 leased shoe departments for other retailers (including Stein Mart, Gordmans, and Filene's Basement), and the e-commerce platform dsw.com. The company is a controlled subsidiary of Retail Ventures, Inc. (RVI), which owns approximately 62.9% of DSW's outstanding shares.
Key Financial Metrics
| Metric | Fiscal 2008 (Jan 31, 2009) | Fiscal 2007 (Feb 2, 2008) |
|---|---|---|
| Net Sales | $1,462.9 million | $1,405.6 million |
| Gross Profit | $379.1 million | $370.1 million |
| Gross Margin | 25.9% | 26.3% |
| Operating Profit | $42.8 million | $81.3 million |
| Operating Margin | 2.9% | 5.8% |
| Net Income | $26.9 million | $53.8 million |
| Diluted EPS | $0.61 | $1.21 |
| Comparable Store Sales Change | -5.9% | -0.8% |
| Cash and Investments | $157.5 million | $144.4 million |
| Working Capital | $295.7 million | $282.7 million |
| Long-Term Debt | $0 | $0 |
Liquidity: The company maintains a $150 million secured revolving credit facility expiring in July 2010. As of January 31, 2009, there were no borrowings outstanding, but $17.7 million in letters of credit were issued. Availability under the facility was $132.3 million.
Material Changes vs. Prior Period
- Profitability Decline: Net income decreased 50.0% to $26.9 million, and operating profit dropped 47.4% to $42.8 million. This was driven by a 5.9% decline in comparable store sales due to a challenging economic environment and reduced customer traffic.
- Margin Compression: Gross margin decreased 40 basis points to 25.9%. While merchandise margins improved due to better inventory management and lower markdowns, these gains were offset by increased store occupancy and distribution expenses as a percentage of sales.
- Operating Expenses: Operating expenses increased to 23.0% of net sales (from 20.5% in 2007). Increases were attributed to home office expenses, start-up costs for dsw.com, and unreimbursed expenses related to services provided to Value City Department Stores prior to its bankruptcy.
- Investment Impairments: The company recorded $1.1 million in other-than-temporary impairment charges on auction rate securities and a $0.7 million temporary impairment.
- Store Count: DSW opened 41 new stores in fiscal 2008, bringing the total to 298. However, the company plans to slow expansion to approximately 10 new stores in fiscal 2009.
Guidance, Outlook, and Risks
- Outlook: Management plans to focus on sales growth through dsw.com, preserving liquidity, and strengthening the balance sheet. Capital expenditures for fiscal 2009 are expected to be approximately $35 million.
- Value City Contingency: Value City Department Stores filed for bankruptcy in October 2008. As of January 31, 2009, Value City owed DSW approximately $6.7 million for services rendered. DSW has submitted a proof of claim but notes there is no assurance of collection.
- Affiliate Liquidity Risks: Liquidity risks at parent company Retail Ventures and affiliate Filene's Basement (which closed 11 stores in February 2009) could impact shared service allocations. If RVI or Filene's Basement reduce operations, DSW may be unable to allocate expenses to them, negatively affecting DSW's results.
- Auction Rate Securities: $4.3 million of investments (net of impairments) are in auction rate securities. Due to auction failures, these are classified as long-term investments, creating potential liquidity constraints if they cannot be liquidated.
- Store Expansion Risks: New store openings may not be profitable or may cannibalize existing store sales. The company is evaluating its strategy for fiscal 2010 and beyond.
Key Facts for Investor Verification
- Comparable Sales Trend: Verify the sustainability of the -5.9% comparable store sales decline and whether the economic slowdown is impacting consumer spending on discretionary footwear.
- Value City Receivable: Monitor the status of the $6.7 million receivable from Value City and the likelihood of recovery in the bankruptcy proceedings.
- Affiliate Financial Health: Assess the financial stability of Retail Ventures and Filene's Basement, as their liquidity issues could force DSW to absorb shared service costs previously allocated to them.
- Auction Rate Securities: Review the liquidity status of the $4.3 million investment in auction rate securities and the potential for further impairments.
- Expansion Strategy: Confirm the revised store opening plan (approx. 10 stores in 2009) and the capital allocation strategy in a tightening credit market.