Business context and reporting period
This filing is for DSW Inc., a U.S. footwear and accessories retailer, for the quarter ended October 29, 2011, and the nine months then ended. The request metadata identifies Designer Brands Inc. and 2010 Q3; both differ from the issuer and period shown in the filing. Prior-year comparisons are to the periods ended October 30, 2010.
DSW operated 327 stores and 363 leased departments. Its merger with former parent Retail Ventures closed May 26, 2011; the filing accounts for it as a reverse merger and recasts prior-period presentation. Consequently, reported year-over-year comparisons and share data should be read with the merger and recasting in mind.
Key financial metrics
Amounts below are in U.S. dollars. Revenue and income figures are in millions unless otherwise noted.
- Revenue: Third-quarter net sales were $530.7 million, up 8.5%; nine-month sales were $1,510.6 million, up 11.6%. Comparable sales rose 5.2% and 9.2%, respectively.
- Profit and margins: Third-quarter gross profit was $180.3 million and gross margin was 34.0%, versus 32.5% a year earlier. Operating profit was $80.9 million versus $17.2 million. Nine-month gross margin was 33.6% versus 31.9%; operating profit was $111.5 million versus $90.5 million.
- Net income and EPS: Third-quarter net income was $53.7 million versus $10.1 million; diluted EPS was $0.75 versus a loss of $0.16. Nine-month net income was $176.1 million versus $51.3 million; diluted EPS was $4.30 versus $0.82. The filing reports $155.4 million of nine-month income attributable to shareholders, versus $17.6 million.
- Cash flow: Nine-month operating cash flow was $130.9 million versus $54.1 million. Capital expenditures were $55.3 million; cash used in investing and financing activities was $35.8 million and $92.6 million, respectively. Cash and equivalents increased $2.5 million to $101.7 million.
- Liquidity: At quarter-end, cash plus short-term investments totaled $304.0 million, with another $65.5 million in long-term investments. Working capital was $446.5 million and the current ratio was 2.5.
- Debt and credit: The $143.75 million PIES matured and were settled in September with 3.8 million Class A shares; the filing reports no outstanding borrowing under DSW’s revolving facility and $87.7 million of availability. Letters of credit totaled $12.3 million. The balance sheet reported a $32.3 million warrant liability.
Changes versus the prior comparable period
- Sales growth reflected higher customer traffic and basket size; management reported positive comparable sales across DSW merchandise categories.
- DSW’s third-quarter gross margin improved, with merchandise margin gains attributed to better initial markup and lower markdown activity. For the leased business division, gross margin declined, including a $1.7 million inventory impairment following the Syms and Filene’s Basement bankruptcy announcement.
- Operating expenses were 22.7% of sales in the quarter versus 22.5% a year earlier, and 22.5% for the nine months versus 21.8%. Nine-month expenses included $16.6 million of merger-related transaction and other RVI-related costs.
- Reported earnings were affected by derivative fair-value movements: the quarter included a $20.9 million gain, compared with a $31.7 million charge a year earlier; the nine-month period included a $56.9 million charge. These were non-cash items.
- The nine-month tax benefit was $73.6 million, producing a reported effective tax rate of negative 72.0%. Management attributed the benefit principally to releasing a deferred-tax valuation allowance and other merger-related tax items.
Outlook, risks, contingencies, and unusual items
- Management expected fiscal 2011 capital expenditures of approximately $80 million, planned 17 store openings in fiscal 2011, and at least 20 in fiscal 2012. It stated that operating cash, investments, and credit availability should support operations, seasonal working capital, and planned investment; no earnings or sales guidance was provided.
- After quarter-end, Syms and Filene’s Basement filed for bankruptcy and announced plans to liquidate stores. They owed DSW about $0.7 million for merchandise; DSW had not reserved this receivable. DSW also recorded the $1.7 million inventory impairment noted above and warned of possible further markdowns.
- DSW assumed guarantees on three Filene’s Basement leases. Potential remaining minimum lease obligations could total as much as approximately $70 million, plus operating costs; no liability was recorded for these guarantees, and their enforceability and ultimate exposure were uncertain. One lease guarantee is capped at $3 million.
- The company recorded a $5.5 million liability related to an office lease assumed in the merger, partially offset by eliminating $2.1 million of deferred rent. The filing also reports a $1.6 million impairment of assets associated with that leased facility.
- Other risks include fashion and markdown exposure, higher product costs, economic weakness, reliance on leased-business partners, and merger-related liabilities. The Schottenstein Affiliates held approximately 74.8% of combined voting power. A merger-related shareholder lawsuit settlement remained subject to final court approval.
- DSW paid a $2.00-per-share special dividend and a $0.15 quarterly dividend in September; a further $0.15 quarterly dividend was announced for payment in December 2011.
Important facts for investors to verify
- Confirm the intended issuer and reporting period: this is a DSW Inc. 10-Q for the quarter ended October 29, 2011, not a Designer Brands Inc. filing for 2010 Q3.
- Assess earnings excluding the substantial derivative fair-value effects and the one-time merger-related tax benefit; reported nine-month earnings are materially affected by both.
- Monitor the Syms and Filene’s Basement bankruptcy recovery, the unreserved $0.7 million receivable, inventory exposure, and the outcome of the three lease guarantees.
- Review the effects of the merger’s reverse-merger accounting and share issuance on comparability, ownership, and per-share results.
- Check subsequent results against planned store openings and capital spending, and evaluate whether margin gains can persist amid markdown, supply-cost, and leased-business pressures.