Business context and reporting period
This is DSW Inc.’s unaudited Form 10-Q for the quarter ended July 30, 2016, with comparisons to the quarter ended August 1, 2015; it also reports six-month results. The request metadata labels the period “2015 Q2,” but the filing itself covers 2016 Q2. DSW operated 480 stores and its e-commerce site, alongside its Affiliated Business Group (ABG), an investment in Town Shoes, and newly acquired digital retailer Ebuys.
Key financial metrics
| Metric | Three months ended July 30, 2016 | Six months ended July 30, 2016 |
|---|---|---|
| Net sales | $658.9 million; up 5.1% year over year | $1,340.2 million; up 4.5% |
| Operating profit | $39.6 million, versus $59.6 million | $88.3 million, versus $133.2 million |
| Net income | $25.0 million, versus $37.6 million | $55.0 million, versus $85.0 million |
| Diluted EPS | $0.30, versus $0.42 | $0.67, versus $0.95 |
| Gross margin | 28.4%, versus 30.5% | 29.2%, versus 31.5% |
| Operating cash flow | Not separately reported for the quarter | $61.1 million, versus $114.6 million |
| Capital expenditures / free cash flow | Not separately reported for the quarter | $43.7 million / $17.4 million, versus $53.8 million / $60.8 million |
At July 30, cash and equivalents were $62.3 million; short- and long-term investments totaled $181.4 million. Current assets were $771.0 million, current liabilities $314.4 million, working capital $456.5 million, and the current ratio 2.5. DSW reported no borrowings under its $100 million secured credit facility and no long-term debt outstanding. Shareholders’ equity was $941.4 million.
Material changes versus the prior comparable period
- Sales grew, but comparable sales declined 1.2% in the quarter and 1.4% for six months. Ebuys contributed $19.6 million and $34.7 million in sales, respectively; non-comparable and closed-store sales also contributed to growth.
- Operating profit and net income fell as gross margin contracted and operating expenses rose as a share of sales. Management cited lower initial markup, sharper pricing and higher markdowns, as well as higher marketing, technology and fulfillment costs.
- Six-month reported net income included $8.4 million in pretax Ebuys purchase-accounting, transaction and fair-value charges, and $2.7 million in restructuring costs. The filing estimates these reduced diluted EPS by $0.06 and $0.02, respectively.
- Operating cash flow and free cash flow declined substantially year over year, primarily due to lower earnings and working-capital changes. Inventory was $556.2 million at quarter-end, up from $505.2 million a year earlier.
Outlook, management commentary, risks and unusual items
- Management said current cash, investments, operating cash generation and available credit were expected to be sufficient for operations, seasonal working capital and planned capital spending. Fiscal 2016 capital expenditures were expected to be approximately $85 million, and the company planned to open 34 DSW stores.
- DSW acquired Ebuys on March 4, 2016, for a stated total purchase price of $116.4 million. The preliminary purchase-price allocation included $55.1 million of goodwill and $41.1 million of intangible assets. The contingent consideration liability was $59.6 million at quarter-end and is revalued each reporting period; the quarter’s revaluation charge was $2.2 million.
- On August 2, 2016, DSW signed an exclusive Middle East franchise agreement that could allow up to 40 stores, with initial openings expected in fiscal 2017. The filing identifies risks including franchisee execution and brand standards, fashion and comparable-sales volatility, vendor and fulfillment dependence, information security, leases, acquisitions, foreign sourcing and currency exposure.
- Construction commitments were $5.8 million. Lease agreements had been signed for 28 planned stores, with total annualized rent of $7.9 million and expected construction and tenant allowances of $11.5 million. Management said pending legal proceedings were not expected to have a material effect; no impairment was recorded in the six-month period.
- The board declared a quarterly dividend of $0.20 per share after quarter-end. Disclosure controls were assessed as effective, and the filing reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the reporting-period mismatch in the request metadata: the filing is for Q2 2016, not Q2 2015.
- Assess whether comparable-sales trends, markdowns and gross-margin pressure persist, and distinguish organic performance from Ebuys contributions.
- Track Ebuys integration, final purchase accounting, milestone performance and changes in the $59.6 million contingent consideration estimate.
- Review cash conversion, inventory levels, planned capital spending and store-opening economics against management’s stated liquidity assessment.
- Monitor Town Shoes exposure, currency effects and execution of the new international franchise arrangement.