Business context and reporting period
DSW Inc. (now Designer Brands Inc.) filed this unaudited Form 10-Q for the quarter ended August 2, 2014, with comparisons to August 3, 2013. The supplied metadata says “2013 Q2,” but the filing itself reports fiscal 2014 Q2. DSW operated 410 stores and dsw.com; its other reportable segment, Affiliated Business Group (ABG), supplied partner retailers and operated a Yellow Box store.
Financial performance
| Metric | Three months ended Aug. 2, 2014 | Three months ended Aug. 3, 2013 | Six months ended Aug. 2, 2014 | Six months ended Aug. 3, 2013 |
|---|---|---|---|---|
| Net sales | $587.1 million | $562.1 million | $1,186.0 million | $1,163.4 million |
| Operating profit | $53.3 million | $54.0 million | $114.6 million | $108.3 million |
| Net income | $34.3 million | $33.7 million | $73.0 million | $68.2 million |
| Diluted EPS | $0.38 | $0.37 | $0.80 | $0.74 |
| Gross margin | 29.3% | 32.6% | 30.3% | 31.5% |
| Operating margin | 9.1% | 9.6% | 9.6% | 9.3% |
Quarterly sales rose 4.5%; six-month sales rose 1.9%. Comparable sales declined 1.5% for the six-month period, while Q2 comparable sales increased 0.8%. Six-month operating cash flow was $97.7 million, down from $147.1 million. Capital expenditures were $48.1 million; financing cash outflows were $86.5 million, including $55.2 million of share repurchases and $33.8 million of dividends.
At August 2, 2014, cash and equivalents were $87.4 million, short-term investments $151.6 million and long-term investments $226.0 million. Current assets were $756.8 million versus current liabilities of $300.1 million; reported working capital was $456.6 million and the current ratio 2.5. There was no outstanding debt under the $50 million revolving facility; the company reported $50 million available. The credit facility requires at least $125 million of qualifying cash and short-term investments. Total assets were $1.434 billion and shareholders’ equity $991.2 million.
Material changes versus the prior comparable period
- Despite higher sales, gross margin fell 3.3 percentage points in Q2 and 1.2 points for the first half, mainly due to markdowns, clearance activity and shipping costs associated with the charge/send system. Management also cited weaker-than-usual prior-year clearance activity.
- Six-month comparable sales declined, primarily reflecting lower customer traffic, partly offset by improved conversion. Women’s footwear was weak; men’s, athletic and accessories performed better.
- Operating expenses as a percentage of sales improved year over year, partly because the prior year included a pension-plan settlement charge and current-year incentive compensation was lower.
- DSW invested in a 49.2% interest in Canada’s Town Shoes for approximately $68.9 million, including a $46.6 million purchase of its subordinated note. Town Shoes contributed $0.8 million of reported income, which included note interest offset by operating losses.
Outlook, commentary, risks and unusual items
Management expected fiscal 2014 capital expenditures of approximately $120 million and planned 35 new DSW stores for the year; 16 had opened in the first half. It described the omni-channel initiative, assortment planning, customer engagement, co-branded credit cards and Yellow Box expansion as strategic priorities. The filing gives no specific sales or earnings guidance.
Risks highlighted include comparable-sales and traffic volatility, fashion and markdown execution, new-store profitability, supply and distribution disruption, partner relationships, data and information-system security, foreign sourcing and currency exposure, and the Town Shoes investment. The company reported a $1.3 million impairment related to three stores. A remaining Filene’s Basement lease guarantee was estimated at $3.3 million, with a stated possible loss range of zero to $7.0 million. Management said current legal proceedings were not expected to be material overall. DSW reported effective disclosure controls and no material change in internal control over financial reporting.
A $0.01 per share benefit from RVI-related income contributed to six-month EPS; $0.4 million of discontinued-operations income came from a final Filene’s Basement estate distribution. The prior-year comparison included pension settlement effects and a luxury test, which management excluded in certain gross-profit comparisons. A $0.1875-per-share quarterly dividend was declared after quarter-end for payment September 30, 2014.
Important facts for investors to verify
- Confirm the period: the filing covers Q2 and the first half of fiscal 2014, not 2013 as stated in the request metadata.
- Track whether sales and traffic trends improve and whether markdown pressure reverses; sales growth outpaced comparable sales due to new and non-comparable locations.
- Assess cash generation against inventory needs, planned capital spending, dividends and repurchases, including compliance with the $125 million liquidity covenant.
- Review returns, currency exposure and the purchase/put options associated with the Town Shoes investment and note.
- Monitor the Union Square lease-guarantee litigation and the expected costs and performance of new stores and strategic initiatives.