DBI

DSW Inc. (DSW) 10-K Summary: Fiscal Year Ended January 29, 2011

Business Context and Reporting Period

This report covers the fiscal year ended January 29, 2011 (Fiscal 2010). DSW Inc. is a leading U.S. branded footwear specialty retailer operating 311 stores in 39 states and an e-commerce platform (dsw.com). The company also operates 352 leased departments for four other retailers (Stein Mart, Gordmans, Filene's Basement, and Frugal Fannie's). DSW is a controlled subsidiary of Retail Ventures, Inc. (RVI), which owned approximately 62% of DSW's outstanding shares and 93% of the combined voting power as of the reporting date.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 13.7% year-over-year, driven by a 13.2% increase in comparable store sales. This growth was attributed to increased transaction volume and higher conversion rates across all merchandise categories.
• Margin Expansion: Gross profit margin improved to 31.0% from 29.2%, primarily due to strong spring season performance which reduced markdown activity. Operating margin expanded significantly to 9.5% from 5.8% due to sales leverage and expense management.
• Profitability: Net income nearly doubled, rising 96.6% to $107.6 million. Diluted earnings per share increased to $2.40 from $1.23.
• Store Count: The company opened 9 new DSW stores and closed 3, ending the year with 311 locations. Leased departments decreased slightly to 352.
• Investment Activity: Capital expenditures more than doubled to $52.3 million, focused on new store openings, remodels, and IT infrastructure. The company also significantly increased its long-term investment portfolio to $50.0 million.

Guidance, Outlook, and Risks

Merger with Retail Ventures: On February 8, 2011, DSW announced a proposed merger with its parent company, Retail Ventures (RVI). Under the agreement, RVI will merge into a DSW subsidiary. RVI shareholders will receive 0.435 DSW Class A shares for each RVI share. The transaction is expected to close in the second quarter of fiscal 2011, subject to shareholder approval and regulatory conditions. The merger is expected to be a tax-free reorganization.

Outlook: Management plans to open 15 to 20 new DSW stores in fiscal 2011 and 10 to 15 stores annually for the following three to five years. Capital expenditures for fiscal 2011 are projected to be approximately $70 million.

Risks and Contingencies:

• Merger Litigation: Two putative shareholder class action lawsuits have been filed challenging the merger agreement, alleging breaches of fiduciary duty. These could delay or prevent the merger.
• Leased Department Risk: Approximately 7.8% of sales come from leased departments. The financial health of partners like Stein Mart and Gordmans is critical; their bankruptcy or liquidation would materially impact DSW.
• Vendor Concentration: The top three vendors accounted for approximately 20% of net sales in fiscal 2010.
• Economic Conditions: Uncertain economic conditions and consumer spending habits remain a risk to future sales and profitability.

Key Facts for Investor Verification

• Merger Status: Verify the progress of the proposed merger with Retail Ventures, including shareholder vote results and any updates on the pending litigation.
• Leased Partner Health: Monitor the financial stability of key leased department partners (Stein Mart, Gordmans, Filene's Basement) given their impact on DSW's revenue stream.
• Inventory Management: Assess the company's ability to maintain gross margins in a challenging economic environment, specifically regarding markdown levels and inventory turnover.
• Store Expansion Execution: Track the opening of the planned 15-20 new stores for fiscal 2011 and their initial performance metrics.
• Debt Covenants: Confirm continued compliance with the $100 million revolving credit facility, particularly the fixed charge coverage ratio if borrowings exceed $25 million.