Business context and reporting period
This filing is DSW Inc.’s unaudited Form 10-Q for the quarter ended October 29, 2016, comparing the three- and nine-month periods with the periods ended October 31, 2015. The supplied metadata says “2015 Q3,” but the filing itself reports fiscal 2016 Q3. DSW operated its footwear stores and website, the Affiliated Business Group (ABG), and, following its March 2016 acquisition, Ebuys. It also held an equity investment in Town Shoes.
Financial performance
| Metric | Three months ended Oct. 29, 2016 | Nine months ended Oct. 29, 2016 | Comparable prior period |
|---|---|---|---|
| Net sales | $696.6 million, up 4.7% | $2,036.8 million, up 4.5% | $665.5 million; $1,948.2 million |
| Gross margin | 30.4%, up 0.5 percentage points | 29.6%, down 1.4 percentage points | 29.9%; 31.0% |
| Operating profit | $62.9 million, down 0.7% | $151.2 million, down 23.0% | $63.3 million; $196.5 million |
| Net income | $39.0 million, down 0.8% | $94.0 million, down 24.3% | $39.3 million; $124.3 million |
| Diluted EPS | $0.47, versus $0.44 | $1.14, versus $1.39 | |
| Operating cash flow | Not separately stated | $110.6 million | $145.3 million |
| Free cash flow (non-GAAP) | Not separately stated | $45.5 million | $63.2 million |
Quarterly sales benefited from Ebuys and non-comparable store sales despite a 2.0% decline in comparable sales. Nine-month comparable sales declined 1.6%. Ebuys contributed $21.3 million of quarterly and $56.0 million of year-to-date sales. DSW’s quarterly segment gross margin improved to 31.9% from 30.4%; its nine-month margin fell to 30.7% from 31.6%.
Financial position and liquidity
At October 29, 2016, cash and equivalents were $61.0 million, short-term investments $78.5 million, and long-term investments $76.1 million. Current assets were $748.1 million and current liabilities $304.9 million; working capital was $443.2 million and the current ratio was 2.5. Total liabilities were $508.5 million and shareholders’ equity was $923.4 million. DSW reported no borrowings under its $100 million credit facility and $100 million of availability. It had $4.9 million of letters of credit under a separate agreement.
Nine-month capital expenditures were $65.2 million. Operating cash flow declined year over year, primarily because of working-capital changes and lower net income. Cash used for dividends was $49.1 million and share repurchases were $42.7 million during the period.
Material changes, outlook, and risks
- Ebuys acquisition: DSW paid $59.5 million in cash; the updated preliminary purchase price was $113.3 million, including $53.8 million of acquisition-date contingent consideration. The liability was $58.9 million at quarter-end after a $5.1 million year-to-date fair-value charge. Purchase accounting, transaction-related and fair-value charges contributed to $11.5 million of reported pre-tax charges for the nine months.
- Costs and margins: Nine-month gross margin weakened amid lower initial markup, category mix and higher markdowns. Operating expenses as a share of sales rose in both reported periods; management cited Ebuys-related costs, restructuring, and comparison with prior-year incentive-compensation reversals. Restructuring expense was $4.1 million year to date.
- Management outlook: DSW expected approximately $85 million of fiscal 2016 capital expenditures and planned 34 store openings that fiscal year. It stated that operating cash flow, cash and investments, and credit availability should fund operations, seasonal working capital and planned investment. No earnings or sales guidance was provided in the supplied filing text. A Middle East franchise agreement could add up to 40 stores, with initial openings planned for fiscal 2017.
- Risks and contingencies: Management highlighted fashion and comparable-sales volatility, vendor and partner relationships, store execution, fulfillment and information systems, data security, foreign sourcing and currency exposure, leases, acquisitions, and cash and investment risks. Legal proceedings were described as incidental; management did not expect their potential liability to be material. The Town Shoes co-investor held put options beginning in fiscal 2017, while DSW held call options beginning in fiscal 2018.
- Capital returns: A $0.20-per-share dividend was declared after quarter-end. DSW also repurchased 0.4 million shares for $7.3 million after quarter-end; $33.5 million remained under the repurchase plan at that time.
Important facts for investors to verify
- Confirm the reporting period: the filing covers fiscal 2016 Q3, not 2015 Q3 as stated in the request metadata.
- Assess whether comparable-sales trends and Ebuys contributions support sustainable growth, apart from new stores and acquisition accounting.
- Review the assumptions, milestone outcomes, and potential earnings effects behind the $58.9 million contingent-consideration liability and the still-preliminary Ebuys purchase-price allocation.
- Track gross-margin recovery, markdowns, fulfillment costs, restructuring charges, and operating cash flow through the holiday season.
- Evaluate liquidity and capital allocation alongside planned store and technology spending, dividends, repurchases, and potential Town Shoes option-related funding needs.