DBI

Business Context and Reporting Period

Company: DSW Inc. (formerly a wholly-owned subsidiary of Retail Ventures, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 30, 2005
Business Overview: DSW operates 184 company-owned stores and leased shoe departments in retailers such as Stein Mart, Gordmans, and Filene's Basement. The company sells better-branded footwear and accessories.
Key Event: DSW completed its Initial Public Offering (IPO) on July 5, 2005, listing on the NYSE under the symbol "DSW". Proceeds were used to repay intercompany debt and fund working capital.

Key Financial Metrics

Liquidity: The company entered into a new $150 million secured revolving credit facility upon the IPO. As of July 30, 2005, there were no direct borrowings outstanding, with $131.1 million available.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 17.8% ($41.8 million) for the quarter and 19.5% ($91.0 million) for the six months compared to the prior year periods. This was driven by the opening of 26 new DSW stores and 15 new leased shoe departments.
• Comparable Store Sales: Comparable store sales improved 3.3% for the quarter and 3.9% for the six months. Growth was led by women's and athletic categories, while accessories declined.
• Profitability: Operating profit margins expanded to 7.5% for the quarter (from 6.7%) and 6.4% for the six months (from 6.3%), aided by the leveraging of operating expenses.
• Interest Expense: Interest expense increased significantly ($4.3 million for the quarter; $7.0 million for six months) due to high-interest intercompany notes issued to fund dividends prior to the IPO. These notes were fully repaid in July 2005 using IPO proceeds.
• Cash Flow: Net cash provided by operating activities turned positive at $16.2 million for the six months ended July 30, 2005, compared to a use of $4.6 million in the prior year period.

Guidance, Risks, and Unusual Items

• Unusual Item (Data Theft): The company accrued a $6.5 million charge in the first quarter of fiscal 2005 related to a credit card data theft incident affecting approximately 1.4 million customers. Management estimates potential exposure between $6.5 million and $9.5 million. No material negative effect on sales trends has been discerned to date.
• Accounting Changes: The company is evaluating the impact of SFAS No. 123R (Share-Based Payment), with adoption delayed until the beginning of fiscal 2006. Pro forma net income would be slightly lower if fair value accounting were applied currently.
• Expansion Plans: Management plans to open approximately 30 new stores per year from fiscal 2005 through fiscal 2008. Average investment per new store is approximately $1.7 million.
• Risks: Key risks include dependence on parent company (RVI) for services, competition, inventory valuation, and potential future legal proceedings related to the data theft.

Investor Verification Checklist

• IPO Proceeds Utilization: Verify the full repayment of the $190 million in intercompany dividend notes and the establishment of the new $150 million credit facility.
• Data Theft Liability: Monitor the $6.5 million to $9.5 million estimated exposure range for the credit card theft incident and any updates on legal proceedings.
• Comparable Store Sales: Track the sustainability of the 3.3% to 3.9% comparable store sales growth, particularly given the decline in the accessories category.
• Inventory Levels: Review inventory build-up ($23.2 million increase in six months) relative to sales growth to assess potential markdown risks.
• Stock-Based Compensation: Assess the future impact of adopting SFAS No. 123R on net income starting in fiscal 2006.