DBI

Business Context and Reporting Period

Company: DSW Inc. (Ticker: DSW)
Filing Type: Form 10-K (Annual Report)
Period Ended: January 30, 2010 (Fiscal Year 2009)
Business Overview: DSW is a leading U.S. branded footwear specialty retailer operating 305 stores in 39 states and 356 leased departments for four other retailers (Stein Mart, Gordmans, Filene's Basement, and Frugal Fannie's). The company also operates an e-commerce channel, dsw.com. DSW is a controlled subsidiary of Retail Ventures, Inc. (RVI), which owns approximately 62.4% of DSW's outstanding shares.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 9.5% year-over-year, driven by a 3.2% increase in comparable store sales, new store openings (9 new stores in FY2009), and growth in dsw.com sales.
• Profitability Expansion: Net income more than doubled, increasing 103.5% to $54.7 million. Operating profit margin improved significantly from 2.9% to 5.8%.
• Margin Improvement: Gross margin expanded by 330 basis points to 29.2%, primarily due to a 190 basis point increase in merchandise margin (driven by reduced markdowns) and a 120 basis point decrease in store occupancy expenses.
• Comparable Sales: DSW segment comparable sales rose 4.0%, led by strong performance in women's footwear (+4.9%) and accessories (+12.6%), offset by a decline in men's footwear (-3.8%). Leased department comparable sales declined 3.6%.
• Investment Impairments: The company recorded other-than-temporary impairments on auction rate securities of $2.9 million in FY2009 (net of $0.5 million realized gains), compared to $1.1 million in FY2008.

Guidance, Outlook, and Risks

• Store Expansion: Management plans to open approximately 10 new DSW stores in fiscal 2010, focusing on power strip centers and existing markets. The average investment per new store is approximately $1.4 million.
• Capital Expenditures: Expected capital expenditures for fiscal 2010 are approximately $40 million, covering new stores, remodels, and IT infrastructure.
• Credit Facility: DSW has a $150 million secured revolving credit facility expiring in July 2010. As of January 30, 2010, there were no borrowings outstanding, but $17.4 million in letters of credit were issued. The company is seeking a replacement facility, noting that terms may differ due to current credit market conditions.
• Key Risks:
  • Economic Conditions: A slowdown in the U.S. economy could reduce consumer spending, traffic, and comparable store sales.
  • Leased Department Dependency: Sales from leased departments represent 9.2% of total sales. The financial health of partners (e.g., Filene's Basement bankruptcy in 2009) poses a risk.
  • Vendor Concentration: The top three vendors accounted for approximately 21% of net footwear sales in FY2009.
  • Related Party Control: Retail Ventures controls approximately 93% of the voting power, which may delay or prevent changes in control favored by other shareholders.

Investor Verification Checklist

• Credit Facility Renewal: Verify the status of the replacement credit facility negotiations given the July 2010 expiration date.
• Leased Department Stability: Monitor the financial health of key leased partners (Stein Mart, Gordmans, Filene's Basement) and the impact of the Filene's Basement bankruptcy on future sales.
• Inventory Management: Assess the sustainability of the reduced markdown activity that drove gross margin expansion, particularly in a challenging economic environment.
• Investment Portfolio: Review the composition of the $289.3 million cash and short-term investment portfolio for exposure to auction rate securities or other illiquid assets.
• Related Party Transactions: Review the terms of the Shared Services Agreement and Tax Separation Agreement with Retail Ventures for potential cost increases or conflicts of interest.