Designer Brands Inc. — Form 10-Q summary
Period clarification: The supplied filing covers the quarter ended November 2, 2019 (fiscal 2019 third quarter), not 2018 Q3. Comparisons below are with the quarter ended November 3, 2018. The Camuto Group acquisition closed November 5, 2018, so the current-period results include it while the comparable quarter does not.
Business context and reporting period
Designer Brands operates U.S. Retail, Canada Retail, and Brand Portfolio segments, alongside smaller operations reported as Other. Brand Portfolio includes Camuto Group wholesale, First Cost services, and branded e-commerce. The nine-month period ended November 2, 2019 also includes the company’s 40% equity-method investment in ABG-Camuto.
Financial results and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $936.3 million | $833.0 million | $2,675.0 million | $2,340.4 million |
| Operating profit | $56.1 million | $53.1 million | $141.4 million | $116.0 million |
| Net income | $43.5 million | $39.3 million | $102.1 million | $25.3 million |
| Diluted EPS | $0.60 | $0.48 | $1.36 | $0.31 |
| Gross margin | 28.9% | 32.6% | 29.4% | 31.3% |
Q3 revenue rose 12.4%; nine-month revenue rose 14.3%. Q3 comparable sales increased 0.3% overall, with Canada up 4.4% and U.S. Retail flat. Nine-month comparable sales increased 0.8% overall. Q3 net income included $5.1 million of after-tax charges, primarily impairment and integration/restructuring costs; the comparable quarter included $18.6 million of after-tax charges, primarily acquisition activity and the Town Shoes exit.
For the nine months, operating cash flow was $118.1 million, down from $147.3 million. Capital expenditures were $59.6 million; investing cash outflow was $10.3 million and financing cash outflow was $120.6 million, including $141.6 million of share repurchases and $54.7 million of dividends. Cash and cash equivalents were $87.8 million at November 2, 2019, with investments of $25.9 million.
Debt under the revolving credit facility was $235.0 million, with $162.0 million available to borrow and $3.0 million in letters of credit. The company reported compliance with its financial covenants. The balance sheet also reported $1.065 billion of operating lease liabilities following adoption of the new lease standard.
Material changes and management commentary
- Camuto Group contributed $106.7 million of external net sales in Q3. Its addition drove much of the revenue growth; U.S. Retail sales were down 0.7% and Canada Retail sales were down 4.7% in the quarter.
- Q3 consolidated gross margin fell 370 basis points. Management attributed the decline mainly to increased U.S. promotions and higher shipping costs associated with digital sales; Canada margins improved on lower clearance activity and better occupancy-cost leverage.
- Management cited weather, tariffs, and system implementation issues as Q3 headwinds. It said the Canada business continued to produce positive comparable sales and margin improvement, and expected most DSW private-label production to transition to Brand Portfolio in fiscal 2020, with anticipated exclusivity and margin benefits.
- The company expected approximately $80 million of fiscal 2019 capital expenditures; $59.6 million had been spent through the first nine months. No specific earnings or revenue guidance was provided.
- During the first quarter, the company adopted the lease accounting standard, recording lease assets and liabilities and a $9.6 million reduction to retained earnings. This affects balance-sheet comparability with prior periods.
Risks, contingencies, and unusual items
- Foreign payroll and other tax exposures identified in the Camuto acquisition were estimated at $15.5 million to $30.0 million. The company recorded a $15.5 million liability and a $12.7 million indemnification asset, but cautioned that estimates could change and collection from the sellers is not assured.
- Management highlighted tariff and trade risks, including possible pressure on product costs, prices, margins, and consumer demand; almost all merchandise is manufactured outside the U.S., with the majority in China.
- The company recorded $4.8 million of impairment charges in the nine months, mainly for Brand Portfolio locations planned for consolidation and underperforming Canada stores. Integration and restructuring costs were $13.6 million in the nine months, including severance, costs to terminate joint ventures, and professional and other integration costs.
- A lease guarantee related to a location leased to a third party represented approximately $14.2 million of future minimum payments. The company said pending legal proceedings were not expected to have a material effect.
- Other identified risks include acquisition integration, fashion and consumer demand, vendor and wholesale relationships, distribution and information systems, foreign currency, and access to liquidity. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported growth and earnings reflects Camuto Group and other acquisition-related effects versus organic performance.
- Whether U.S. Retail can recover gross margin after Q3 promotional and shipping-cost pressure, and whether Canada’s sales and margin gains continue.
- The realized costs and benefits of tariffs, digital growth, and the planned fiscal 2020 private-label production transition.
- Changes in the $15.5 million to $30.0 million foreign tax exposure, and whether the company collects the recorded indemnification asset.
- Cash generation, seasonal inventory needs, share repurchases, and debt availability under the credit facility and its covenants.