Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended May 5, 2007 for DSW Inc. (DSW), a leading U.S. specialty branded footwear retailer. As of the reporting date, DSW operated 230 stores across 36 states and leased shoe departments within four other retailers (Stein Mart, Gordmans, Filene's Basement, and Frugal Fannie's). The company is a controlled subsidiary of Retail Ventures, Inc. (RVI), which held approximately 63.0% of DSW's outstanding common shares.
Key Financial Metrics
| Metric | Q1 2007 (Ended May 5) | Q1 2006 (Ended April 29) |
|---|---|---|
| Net Sales | $356.997 million | $316.487 million |
| Gross Profit | $109.256 million | $93.287 million |
| Gross Margin | 30.6% | 29.5% |
| Operating Profit | $37.218 million | $27.889 million |
| Operating Margin | 10.4% | 8.8% |
| Net Income | $23.744 million | $17.519 million |
| Diluted EPS | $0.54 | $0.40 |
| Cash from Operations | $15.168 million | $38.234 million |
| Cash and Equivalents | $76.036 million | $159.288 million (End of Q1 2006) |
| Short-term Investments | $99.250 million | $98.650 million |
| Long-term Debt | $0 | $0 |
| Available Credit Facility | $141.954 million | $136.552 million |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 12.8% ($40.5 million) year-over-year, driven by the addition of 26 new DSW stores and 124 new leased shoe departments. However, comparable store sales decreased 3.6% due to declines in women's, men's, and accessories categories, partially offset by growth in athletic footwear.
- Profitability: Net income rose 35.5% to $23.7 million. Gross margin expanded to 30.6% due to increased initial markups and reduced markdown rates, despite higher warehouse and occupancy expenses.
- Cash Flow: Operating cash flow decreased significantly to $15.2 million from $38.2 million in the prior year, primarily due to a $20.3 million increase in inventory levels to support new store openings.
- Capital Expenditures: Total capital expenditures were $18.7 million, with $9.3 million paid in cash during the quarter. This included $5.5 million for new stores/remodels and $6.8 million for corporate office expansion and IT/e-commerce development.
Guidance, Outlook, and Risks
- Expansion Plans: Management plans to open at least 30 new stores annually for fiscal 2007 and the following three years. Total capital expenditures for fiscal 2007 are expected to be approximately $80 million.
- Liquidity: The company maintains a $150 million secured revolving credit facility with no borrowings outstanding. Management expects to fund operations and expansion through existing cash, operating cash flows, and the credit facility if needed.
- Legal Contingencies: DSW is involved in legal proceedings related to a 2005 credit card data theft involving 1.4 million cards. The company estimates potential exposure between $6.5 million and $9.5 million. As of May 5, 2007, an accrual of $3.1 million remained. One class action lawsuit was resolved in May 2007 in the company's favor.
- Accounting Changes: The company adopted FASB Interpretation No. 48 (FIN 48) regarding uncertainty in income taxes, resulting in a $0.1 million unfavorable adjustment to retained earnings.
Investor Verification Checklist
- Comparable Store Sales: Verify the sustainability of the 3.6% decline in comparable store sales and the specific drivers behind the drop in women's and men's seasonal categories.
- Inventory Levels: Assess the $20.3 million increase in inventory against the pace of new store openings to ensure no overstocking risks exist.
- Legal Exposure: Monitor the status of the remaining class action lawsuit regarding the 2005 data theft and any potential changes to the $3.1 million accrual.
- Capital Allocation: Review the execution of the $80 million capital expenditure plan, specifically the ROI on the $6.8 million invested in corporate expansion and e-commerce.
- Related Party Transactions: Note the significant ownership by Retail Ventures, Inc. (63%) and the existence of warrants held by SSC and Cerberus that could impact share structure.