Business context and reporting period
Designer Brands Inc. filed this unaudited Form 10-Q for the second quarter of fiscal 2019, the three and six months ended August 3, 2019. The company operates U.S. Retail, Canada Retail and Brand Portfolio segments. Results include Camuto Group, acquired in November 2018; therefore, year-over-year comparisons are affected by acquisitions and store closures. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $860.2 million | $795.3 million | $1,738.7 million | $1,507.4 million |
| Net income (loss) | $27.4 million | $(38.4) million | $58.6 million | $(14.1) million |
| Diluted EPS | $0.37 | $(0.48) | $0.77 | $(0.18) |
| Operating profit | $41.3 million | $24.5 million | $85.2 million | $62.9 million |
| Gross margin | 30.0% | 32.1% | 29.7% | 30.6% |
| Operating cash flow | Not separately presented | Not separately presented | $34.2 million | $106.6 million |
Q2 total revenue rose 8.2%; net sales rose 7.0%, while comparable sales declined 0.6%. Q2 net income included $8.3 million of after-tax integration and restructuring charges. The prior-year quarter included $89.3 million of after-tax charges, primarily associated with the Canadian retail acquisition. Q2 operating profit margin was 4.8% of revenue, compared with 3.1%; net margin was 3.2%, compared with a 4.8% loss.
For the first half, cash used in investing activities was $4.5 million net cash provided, including $40.3 million of capital expenditures and proceeds from investment sales. Financing activities used $87.2 million, including $125.0 million for share repurchases and $36.8 million in dividends. Cash and cash equivalents were $51.8 million at August 3, down from $99.4 million at fiscal year-end.
At August 3, total debt was $235.0 million, all under the revolving credit facility; $163.7 million remained available. The company reported compliance with financial covenants. Current assets were $924.2 million and current liabilities were $648.9 million. The balance sheet included $1.092 billion in operating lease liabilities, following adoption of the new lease accounting standard in fiscal 2019.
Material changes versus prior period
- Camuto Group contributed $78.9 million in external Q2 net sales; it was not included in the prior-year quarter. Its inclusion increased revenue but weighed on consolidated gross margin.
- Q2 U.S. Retail comparable sales fell 1.5%; Canada Retail comparable sales increased 8.1%, supported by its digital platform and lower clearance inventory. Canada Retail sales comparisons also reflect store closures and the changing comparable-store base.
- Q2 gross margin fell 210 basis points. Management cited the prior-year benefit from a DSW loyalty-program accounting adjustment, higher digital shipping costs, occupancy and fulfillment expense deleverage, and Camuto Group’s lower gross margin. Canada Retail margin improved.
- First-half operating cash flow declined to $34.2 million from $106.6 million, with management citing lower adjusted earnings and higher working-capital needs, including those of acquired businesses.
- The company repurchased 6.1 million Class A shares for $125.0 million in the first half. Weighted-average diluted shares for the quarter were 7.4% lower year over year.
Outlook, commentary and risks
Management said second-quarter results positioned the company to reaffirm its annual guidance, but the filing text does not provide clear numerical guidance figures. It expects to shift DSW private-label production to Brand Portfolio in fiscal 2020, with anticipated benefits from more exclusive products and higher margins. Fiscal 2019 plans included $75–$85 million of capital expenditures and approximately 17–21 new stores.
Management cited progress in Canada and seasonal U.S. product categories, while identifying tariffs as a potential headwind. Key risks include additional tariffs and sourcing disruption, consumer demand and fashion trends, acquisition integration, foreign-tax exposures, distribution and information-system disruptions, foreign exchange, and liquidity and lease obligations.
Camuto-related foreign payroll and other tax contingencies were estimated at $14.8–$30.0 million. The company recorded a $14.8 million liability and a $12.7 million indemnification asset, but collection is not assured. A lease guarantee for a third-party-occupied location had approximately $15.0 million in future minimum payments. Management said current cash, investments, operating cash generation and credit availability should be sufficient for the next 12 months and foreseeable future.
The company adopted lease accounting guidance in the first quarter, recording approximately $1.0 billion of lease assets and $1.1 billion of lease liabilities at transition, and a $9.6 million reduction to retained earnings. Two joint ventures and related arrangements were terminated during Q2; first-half integration and restructuring costs included a $6.1 million termination fee.
Important facts for investors to verify
- Confirm the full-year guidance figures and assumptions; numerical guidance is not clearly stated in this filing.
- Track comparable sales and gross-margin trends by segment, particularly U.S. Retail and the effect of Camuto Group’s product mix and integration.
- Monitor working-capital consumption, cash generation, revolver borrowings and covenant headroom as seasonal inventory builds.
- Assess the resolution and collectability of Camuto-related foreign-tax indemnification claims and any changes to the estimated exposure.
- Evaluate tariff developments, sourcing alternatives, and the company’s ability to pass higher costs through to customers without weakening demand or margins.