Business context and reporting period
Designer Brands Inc. (formerly DSW Inc.; name changed March 19, 2019) filed this unaudited Form 10-Q for the three months ended May 4, 2019, its first quarter of fiscal 2019. The filing compares results with the three months ended May 5, 2018. This differs from the request metadata’s “2018 Q1” label. The company operates U.S. Retail, Canada Retail, and Brand Portfolio segments.
Year-over-year comparisons are substantially affected by acquisitions: TSL became wholly owned in May 2018 and Camuto Group was acquired in November 2018. Neither business was consolidated in the prior-year quarter. Prior-year results also included Ebuys wind-down costs; Ebuys operations ended in the first quarter of fiscal 2018.
Key financial results
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Total revenue | $878.5 million | $712.1 million |
| Gross profit / gross margin | $256.0 million / 29.4% | $205.2 million / 28.9% |
| Operating profit / operating margin | $44.0 million / 5.0% | $38.5 million / 5.4% |
| Net income | $31.2 million | $24.3 million |
| Diluted EPS | $0.40 | $0.30 |
| Operating cash flow | $(3.0) million | $25.3 million |
| Capital expenditures | $24.9 million | $18.2 million |
- Total revenue rose 23.4%; net sales rose 22.5%. Management attributed the increase primarily to $142.5 million of incremental net sales from acquired businesses and 3.0% comparable-sales growth, partly offset by the Ebuys exit.
- U.S. Retail comparable sales increased 3.0%, with higher comparable transactions and strong digital demand. U.S. Retail gross margin increased 70 basis points to 30.3%, reflecting higher initial markups and lower markdowns, partly offset by higher shipping costs.
- Consolidated gross margin improved 50 basis points. Operating margin declined 40 basis points; operating expenses rose 32.3% and increased 180 basis points as a share of revenue, reflecting acquired businesses, integration and restructuring costs, and lease-accounting effects.
- Net income included $2.4 million of net after-tax charges, or $0.03 per diluted share, primarily for integration and restructuring. Prior-year net income included $7.2 million of net after-tax charges, or $0.09 per diluted share, primarily for Ebuys exit costs, TSL acquisition costs, and foreign-exchange losses.
- The effective tax rate was 25.4%, down from 31.9%; management attributed the decrease primarily to prior-year valuation allowances and nondeductible Ebuys exit charges.
Liquidity, debt, and capital allocation
- At May 4, 2019, cash and cash equivalents were $70.7 million, investments were $51.3 million, and current assets and current liabilities were $896.7 million and $596.0 million, respectively.
- Revolving-credit debt was $235.0 million, with $161.9 million available under the $400 million facility after letters of credit. The stated borrowing rate was 4.0%. The company reported compliance with its financial covenants.
- Operating cash flow was negative $3.0 million, versus positive $25.3 million a year earlier. Management cited acquired-business working-capital needs and Camuto Group’s first-quarter net loss among the factors.
- Cash and cash equivalents declined from $99.4 million at February 2, 2019. Financing included $215.2 million of revolving-credit borrowings and $140.2 million of repayments; the company also repurchased $75.0 million of shares and paid $18.9 million of dividends.
- The company repurchased 3.4 million Class A shares for $75.0 million; $401.6 million remained authorized. The board declared a $0.25-per-share quarterly dividend payable July 5, 2019.
- Fiscal 2019 capital expenditures were expected to be approximately $75 million–$85 million, with approximately 17–21 new stores planned.
Material changes, outlook, and risks
- Adoption of the new lease standard on February 3, 2019 recognized approximately $1.0 billion of lease assets and $1.1 billion of lease liabilities, and reduced retained earnings by $9.6 million for transition-related lease impairments. At May 4, total operating lease liabilities were $1.106 billion. Prior periods were not restated.
- Management said Canada Retail generated positive operating profit in the quarter, the first time in five years it had done so at the start of a year. It cited transferring U.S. practices and upgrading the Canadian digital platform.
- Management expected to shift most design, sourcing, and production of DSW U.S. exclusive-brand products to Camuto Group at the start of fiscal 2020, with the aim of lowering product costs. The filing provides no quantified earnings guidance.
- Camuto Group generated $94.0 million of revenue and a $7.5 million net loss in the quarter; TSL generated $51.8 million of revenue and $0.4 million of net income.
- Foreign-tax contingencies related to Camuto Group were estimated at $14.1 million–$30.0 million. The company recorded a $14.1 million liability and a $12.7 million indemnification asset, but warned estimates may change and collection from sellers is not assured. A separate lease guarantee had approximately $16.0 million of future minimum payments.
- Key stated risks include acquisition integration and realizing expected benefits, fashion and consumer-demand shifts, competition, tariffs and foreign sourcing, distribution or information-system disruption, leases, liquidity, and foreign-exchange movements. The company said there were no material changes to previously disclosed risk factors and no material expected liability from current legal proceedings.
Important facts for investors to verify
- How much reported growth and profit improvement is attributable to acquisitions versus comparable-store and digital-sales performance.
- Whether Camuto Group integration, sourcing changes, and expected cost benefits proceed on schedule, and whether the segment reaches profitability.
- Whether operating cash flow recovers after acquired-business working-capital demands, while the company continues repurchases, dividends, and planned capital spending.
- Whether foreign-tax exposures remain within the recorded estimate and whether the company collects the related seller indemnification.
- How lease obligations, revolving debt, and covenant headroom affect liquidity and financial flexibility.