Business context and reporting period
This filing is DSW Inc.’s unaudited Form 10-Q for the quarter ended July 30, 2011, covering fiscal 2011’s second quarter and first six months. The request metadata says “2010 Q2,” but the filing itself reports 2011 results. The registrant is DSW Inc., not Designer Brands Inc.
DSW operates footwear stores and dsw.com, plus leased departments in partner retailers. It reported 319 stores and 352 leased departments at quarter-end. Its May 26, 2011 merger with former parent Retail Ventures (RVI) is accounted for as an equity transaction and reverse merger; pre-merger comparative information represents RVI and was recast for share data, segments, and cost classification.
Financial results and liquidity
| Metric | Three months ended July 30, 2011 | Six months ended July 30, 2011 |
|---|---|---|
| Net sales | $476.3 million, up 14.7% | $979.9 million, up 13.3% |
| Comparable sales growth | 12.3% companywide | 11.5% companywide |
| Gross margin | 32.7%, versus 30.3% | 33.4%, versus 31.6% |
| Operating profit | $26.0 million, versus $56.2 million | $30.6 million, versus $73.3 million |
| Net income attributable to DSW shareholders | $139.9 million, versus $26.9 million | $101.7 million, versus $21.0 million |
| Diluted EPS attributable to DSW shareholders | $3.96, versus $1.00 | $3.54, versus $0.98 |
| Operating cash flow | $65.5 million for six months, versus $13.3 million |
Net income benefited substantially from a $124.6 million quarterly income-tax benefit ($99.7 million for six months), primarily from releasing a valuation allowance and other merger-related tax items. Results also included noncash derivative fair-value charges of $22.9 million for the quarter and $77.8 million for six months. Thus, reported earnings and EPS should not be viewed as a straightforward measure of underlying operating performance.
Gross margin improvement reflected lower markdown activity and, in the DSW segment, lower occupancy costs as a share of sales. Operating expenses rose as a percentage of sales, including $6.1 million of merger-related and other RVI expenses in the quarter and $11.3 million for six months. Net interest expense was $4.9 million for the quarter and $8.1 million for six months.
At July 30, cash and equivalents were $49.6 million, short-term investments $301.1 million, and long-term investments $66.8 million. Current assets were $745.0 million and current liabilities $459.7 million; the current ratio was 1.6. Cash and equivalents fell $49.5 million from fiscal year-end. Six-month investing cash outflow was $113.3 million, including $34.6 million of capital expenditures and net investment purchases.
The $100 million secured revolver had no borrowings outstanding; availability was $75.4 million, with $24.6 million of letters of credit outstanding. The $133.4 million carrying value of PIES was classified as current debt and was scheduled to mature September 15, 2011. The filing reported $101.2 million of derivative liabilities related to the PIES conversion feature and warrants.
Material changes, outlook, and risks
- The RVI merger eliminated noncontrolling interests and brought RVI obligations, including the PIES, warrants, and certain discontinued-operation contingencies, into the consolidated company. The merger also changed the basis and presentation of prior-period comparisons.
- Management reported stronger traffic, transactions, and basket size, with positive comparable sales across DSW merchandise categories. It expected China-sourced product cost increases in the second half of fiscal 2011, while expecting supply-chain and merchandising initiatives to mitigate some impact.
- Management expected approximately $80 million of fiscal 2011 capital expenditures, about 17 store openings in fiscal 2011, and about 20 in fiscal 2012. It stated that operating cash, investments, and revolver availability should fund operations, seasonal working capital, and planned growth.
- After quarter-end, DSW announced a $2.00-per-share special dividend and a new $0.15 quarterly dividend, both payable September 30, 2011. It also announced settlement of the PIES in shares, expected to issue approximately 3.8 million to 4.9 million Class A shares. The credit facility was amended to raise the annual capital-expenditure limit to $100 million and remove the separate $50 million annual dividend limit; the prior-year-earnings dividend restriction remained.
- Key disclosed risks include execution of store expansion, fashion and markdown risk, economic weakness affecting traffic and sales, leased-business partner and supply risks, distribution disruption, merger-related liabilities, potential limits on use of tax attributes, and the voting control of Schottenstein affiliates. Merger-related shareholder litigation settlement remained subject to final court approval. Management said other routine litigation was not expected to be material, while noting estimates could change.
Important facts for investors to verify
- How much of reported earnings reflects the one-time tax benefit, and what is the expected sustainable tax rate after merger-related tax effects?
- What was the final PIES exchange ratio and share issuance, and how did the special and recurring dividends affect cash, share count, and liquidity?
- Whether comparable-sales momentum and improved markdown performance continued, particularly as product costs increased.
- Whether merger-related costs, derivative fair-value volatility, and assumed RVI contingent liabilities resulted in additional charges or cash outflows.
- Whether planned capital spending and store openings remained consistent with the stated outlook and revolver covenants.