Business context and reporting period
DSW Inc. (the filing’s registrant; not identified as Designer Brands Inc. in the supplied text) filed this unaudited Form 10-Q for the quarter ended November 1, 2014, its fiscal 2014 third quarter. The filing compares the quarter and first nine months with the periods ended November 2, 2013. DSW operates its stores and website and an Affiliated Business Group (ABG); it also holds an equity investment in Canadian retailer Town Shoes.
Financial performance and liquidity
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $669.9 million, +5.8% | $1,855.9 million, +3.3% |
| Operating profit | $79.7 million, versus $88.3 million | $194.3 million, versus $196.5 million |
| Net income | $49.6 million, versus $55.0 million | $122.5 million, versus $123.2 million |
| Diluted EPS | $0.55, versus $0.60 | $1.35, versus $1.34 |
| Gross margin | 32.6%, down 1.0 percentage point | 31.2%, down 1.0 percentage point |
For the quarter, DSW comparable sales rose 2.6%; for the nine months, they declined 0.1%. Nine-month operating cash flow was $131.5 million, down from $204.2 million. Capital expenditures were $75.9 million. Cash and equivalents were $96.4 million; short- and long-term investments totaled $330.6 million. The company had no borrowings under its $50 million revolving facility and reported no long-term debt. Current assets were $787.7 million and current liabilities $311.8 million; management reported net working capital of $475.9 million and a 2.5 current ratio.
Material changes and unusual items
- Quarterly sales growth reflected comparable-sales gains and new-store growth; the nine-month increase was driven by non-comparable sales, while comparable sales were slightly negative.
- Margin pressure reflected sharper price points, markdowns, higher ship-from-store costs and $5.0 million of long-lived asset impairments at seven stores. Management said improved inventory alignment, lower markdown rates and category mix partly offset these factors.
- Operating expenses were 20.7% of quarterly sales versus 19.7% a year earlier, reflecting planned omni-channel and marketing investment, partly offset by lower incentive compensation.
- Nine-month operating cash flow fell amid increased inventory, including store-growth needs and opportunistic pre-buys. Financing outflows included $85.3 million of share repurchases and $50.4 million of dividends.
- DSW invested in Town Shoes in May 2014, acquiring a 49.2% interest with 50% voting control, and purchased a $46.6 million Canadian-dollar-denominated note. The investment and note expose DSW to foreign currency risk; DSW said it did not use currency hedges.
- Nine-month results included $0.4 million from discontinued operations, related to a final distribution from the Filene’s Basement bankruptcy estate. Prior-year results included pension settlement effects and a luxury test, complicating comparisons.
Outlook, risks and contingencies
Management expected fiscal 2014 capital expenditures of approximately $105 million and said cash, investments, operating cash flow and available credit should support operations, seasonal working capital, growth investment and dividends. DSW had opened 37 stores in the first nine months and expected assortment-planning benefits beginning in late 2015 or early 2016; the filing gives no earnings or comparable-sales guidance.
Key risks cited include fashion and comparable-sales variability, inventory and markdown management, new-store execution, omni-channel and fulfillment operations, vendor and affiliated-partner relationships, data security, economic conditions, foreign sourcing and currency exposure, and risks associated with Town Shoes and legacy Retail Ventures guarantees. In a Filene’s Basement lease-guarantee case, an appellate court ruled the guarantee enforceable; the expected loss range was zero to $7.0 million, with a damages hearing scheduled for January 2015. DSW recorded an estimated $3.2 million liability for the remaining guarantee. Management said other pending legal matters were not expected to be material.
Important facts for investors to verify
- Confirm the entity and period: the supplied filing is DSW Inc.’s quarter ended November 1, 2014, not a 2013 Q3 filing.
- Track whether comparable-sales trends and gross margins improve, and whether inventory and operating cash flow normalize.
- Assess returns and foreign-currency exposure from the Town Shoes investment and note receivable.
- Monitor the Union Square guarantee case and any resulting liability beyond the recorded estimate.
- Review the effect of planned capital spending, dividends and additional share repurchases on liquidity.