DSW Inc. 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended April 29, 2006
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _________to _________
Commission File Number 1-32545
DSW INC.
(Exact name of registrant as specified in its charter)
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Ohio |
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31-0746639 |
(State or other jurisdiction of
Incorporation or organization)
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(I.R.S. Employer Identification No.) |
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4150 East 5th Avenue Columbus, Ohio |
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43219 |
(Address of principal executive offices)
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(Zip Code) |
(614) 237-7100
Registrants telephone number, including area code
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer
o Accelerated filer
o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
o Yes þ No
The number of outstanding Class A Common Shares, without par value, as of May 31, 2006 was
16,198,528 and Class B Common Shares, without par value, as of May 31, 2006 was 27,702,667.
DSW INC.
TABLE OF CONTENTS
- 2 -
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
DSW INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(unaudited)
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April 29, |
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January 28, |
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2006 |
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2006 |
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ASSETS |
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Cash and equivalents |
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$ |
159,288 |
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$ |
124,759 |
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Accounts receivable, net |
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4,144 |
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4,039 |
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Receivables from related parties |
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12 |
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49 |
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Inventories |
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225,183 |
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216,698 |
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Prepaid expenses and other assets |
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12,230 |
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13,981 |
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Deferred income taxes |
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18,648 |
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18,591 |
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Total current assets |
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419,505 |
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378,117 |
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Property and equipment, net |
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95,188 |
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95,921 |
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Goodwill |
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25,899 |
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25,899 |
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Tradenames and other intangibles, net |
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6,000 |
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6,216 |
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Deferred income taxes and other assets |
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1,882 |
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1,562 |
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Total assets |
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$ |
548,474 |
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$ |
507,715 |
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LIABILITIES AND SHAREHOLDERS EQUITY |
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Accounts payable |
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$ |
96,072 |
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$ |
78,889 |
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Accounts payable to related parties |
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4,761 |
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6,631 |
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Accrued expenses: |
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Compensation |
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4,373 |
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9,933 |
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Taxes |
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21,016 |
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9,557 |
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Advertising |
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10,215 |
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8,586 |
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Other |
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24,645 |
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25,993 |
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Total current liabilities |
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161,082 |
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139,589 |
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Other noncurrent liabilities |
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64,215 |
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63,410 |
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Commitments and contingencies |
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Shareholders equity: |
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Class A Common Shares, no par value;
170,000,000 authorized; 16,198,528
and 16,190,088 issued and outstanding, respectively |
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279,651 |
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281,119 |
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Class B Common Shares, no par value;
100,000,000 authorized; 27,702,667
and 27,702,667 issued and outstanding, respectively |
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Preferred Shares, no par value; 100,000,000
authorized; no shares issued or outstanding |
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Retained earnings |
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43,526 |
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26,007 |
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Deferred compensation |
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(2,410 |
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Total shareholders equity |
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323,177 |
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304,716 |
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Total liabilities and shareholders equity |
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$ |
548,474 |
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$ |
507,715 |
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The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements.
- 3 -
DSW INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share amounts)
(unaudited)
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Three months ended |
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April 29, |
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April 30, |
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2006 |
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2005 |
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Net sales |
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$ |
316,487 |
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$ |
281,806 |
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Cost of sales |
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(223,200 |
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(199,008 |
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Gross profit |
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93,287 |
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82,798 |
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Operating expenses |
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(65,398 |
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(67,745 |
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Operating profit |
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27,889 |
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15,053 |
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Interest income (expense), net |
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Non-related parties |
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1,324 |
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(849 |
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Related parties |
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(2,672 |
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Earnings before income taxes |
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29,213 |
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11,532 |
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Income tax provision |
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(11,694 |
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(4,552 |
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Net income |
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$ |
17,519 |
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$ |
6,980 |
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Basic and diluted earnings per share: |
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Basic |
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$ |
0.40 |
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$ |
0.25 |
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Diluted |
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$ |
0.40 |
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$ |
0.25 |
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Shares used in per share calculations: |
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Basic |
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43,896 |
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27,703 |
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Diluted |
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44,144 |
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27,703 |
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The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements.
- 4 -
DSW INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(in thousands)
(unaudited)
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Number of |
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Class A |
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Class B |
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Class A |
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Class B |
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Deferred |
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Common |
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Common |
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Common |
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Common |
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Retained |
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Compensation |
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Shares |
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Shares |
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Shares |
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Shares |
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Earnings |
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Expense |
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Total |
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Balance, January 29, 2005 |
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27,703 |
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$ |
101,442 |
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$ |
77,384 |
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$ |
178,826 |
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Net income |
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6,980 |
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6,980 |
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Dividend to parent |
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(101,442 |
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(63,558 |
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(165,000 |
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Balance, April 30, 2005 |
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27,703 |
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$ |
0 |
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$ |
20,806 |
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$ |
20,806 |
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Balance, January 28, 2006 |
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16,190 |
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27,703 |
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$ |
281,119 |
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$ |
0 |
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$ |
26,007 |
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$ |
(2,410 |
) |
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$ |
304,716 |
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Net income |
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17,519 |
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17,519 |
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Reclassification of unamortized
deferred compensation |
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(2,410 |
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2,410 |
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Stock units granted |
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1 |
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14 |
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14 |
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Exercise of stock options |
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8 |
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152 |
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152 |
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Tax benefit related to stock
options exercised |
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35 |
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35 |
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Stock based compensation expense,
before related tax effects |
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741 |
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741 |
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Balance, April 29, 2006 |
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16,199 |
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27,703 |
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$ |
279,651 |
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$ |
0 |
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$ |
43,526 |
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$ |
0 |
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$ |
323,177 |
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The accompanying Notes are an integral part of the Condensed Consolidated Financial
Statements.
- 5 -
DSW INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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Three months ended |
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April 29, |
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April 30, |
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2006 |
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2005 |
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Cash flows from operating activities: |
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Net income |
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$ |
17,519 |
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$ |
6,980 |
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Adjustments to reconcile net income
to net cash provided by operating activities: |
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Depreciation and amortization |
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4,901 |
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4,719 |
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Amortization of debt issuance costs |
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30 |
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98 |
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Stock based compensation expense |
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741 |
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Deferred income taxes |
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(217 |
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(3,213 |
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Loss on disposal of assets |
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319 |
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14 |
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Grants of director stock units |
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14 |
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Change in working capital, assets and liabilities: |
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Accounts receivable |
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(105 |
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(774 |
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Accounts receivable from related parties |
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37 |
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Inventories |
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(8,485 |
) |
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(20,071 |
) |
Prepaid expenses and other assets |
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1,561 |
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(5,136 |
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Advances to/from affiliates |
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24,325 |
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Accounts payable |
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14,973 |
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9,636 |
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Proceeds from lease incentives |
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1,624 |
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1,828 |
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Other noncurrent liabilities |
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(819 |
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632 |
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Accrued expenses |
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6,141 |
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6,752 |
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Net cash provided by operating activities |
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38,234 |
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25,790 |
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Cash flows from investing activities: |
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Capital expenditures |
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(3,892 |
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(5,315 |
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Net cash used in investing activities |
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(3,892 |
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(5,315 |
) |
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Cash flows from financing activities: |
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Net decrease in revolving credit facility |
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(15,000 |
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Debt issuance costs |
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(96 |
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Proceeds from exercise of stock options |
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152 |
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Tax benefit related to stock options exercised |
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35 |
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Net cash provided by (used in) financing activities |
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187 |
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(15,096 |
) |
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Net increase in cash and equivalents |
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34,529 |
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5,379 |
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Cash and equivalents, beginning of period |
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124,759 |
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8,339 |
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Cash and equivalents, end of period |
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$ |
159,288 |
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$ |
13,718 |
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The accompanying Notes are an integral part of the Condensed Consolidated Financial
Statements.
- 6 -
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BUSINESS OPERATIONS
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DSW Inc. (DSW) and its wholly-owned subsidiary, DSW Shoe Warehouse, Inc. (DSWSW), are
herein referred to collectively as DSW or the Company. Prior to December 2004, DSW was a
wholly-owned subsidiary of Value City Department Stores, Inc., a wholly-owned subsidiary of
Retail Ventures, Inc. (RVI or Retail Ventures). In December 2004, RVI completed a
corporate reorganization whereby Value City Department Stores, Inc. merged with and into Value
City Department Stores LLC (Value City), another wholly-owned subsidiary of RVI. In turn,
Value City transferred all of the issued and outstanding shares of DSW to RVI in exchange for
a promissory note. On June 29, 2005, DSW commenced an initial public offering (IPO) that
closed on July 5, 2005. DSWs Class A common stock is listed on the New York Stock Exchange
trading under the symbol DSW. |
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DSW operates in two segments and sells better-branded footwear in both. DSW stores also sell
accessories. As of April 29, 2006, DSW operated a total of 204 stores located throughout the
United States as one segment. These DSW stores offer a wide selection of brand name and
designer dress, casual and athletic footwear for men and women. DSW also operates leased shoe
departments for three non-affiliated retailers and one affiliated retailer in our leased
department segment. DSW entered into supply agreements to merchandise the non-affiliated shoe
departments in Stein Mart, Inc. (Stein Mart), Gordmans, Inc. (Gordmans) and Frugal
Fannies Fashion Warehouse (Frugal Fannies) as of July 2002, June 2004 and September 2003,
respectively. DSW has operated leased shoe departments for Filenes Basement, Inc. (Filenes
Basement), a wholly-owned subsidiary of RVI, since its acquisition by RVI in March 2000.
Effective as of January 30, 2005, we updated and reaffirmed our contractual arrangement with
Filenes Basement. DSW owns the merchandise, records sales of merchandise net of returns and
sales tax, owns the fixtures (except for Filenes Basement) and provides supervisory
assistance in these covered locations. Stein Mart, Gordmans, Frugal Fannies and Filenes
Basement provide the sales associates. DSW pays a percentage of net sales as rent. As of
April 29, 2006, DSW supplied 158 leased departments for Stein Mart, 57 for Gordmans, 25 for
Filenes Basement and one for Frugal Fannies. |
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DSW opened five new DSW stores during the three months ended April 29, 2006 and seven new DSW
stores during the three months ended April 30, 2005. In addition, during the three months
ended April 30, 2005, DSW re-categorized two DSW stores as leased departments. |
2. INITIAL PUBLIC OFFERING
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On July 5, 2005, DSW closed on its IPO of 16,171,875 Class A Common Shares raising net
proceeds of $285.8 million, net of the underwriters commission and before expenses of
approximately $7.8 million. DSW used the net proceeds of the offering to repay $196.6 million
of intercompany indebtedness, including interest, owed to RVI and for working capital and
general corporate purposes, including the paying down of $20 million outstanding on RVIs old
secured revolving credit facility and $10 million intercompany advance. The 410.09 common
shares of DSW held by RVI outstanding at January 29, 2005 were changed to |
-7-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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27,702,667 Class B Common Shares. It is the 27,702,667 Class B Common Shares which are being
used in the prior periods calculation of earnings per share. Subsequent to the IPO, the
transactions between DSW and RVI and its other subsidiaries are settled in accordance with a
shared services agreement and resulted in the advances from affiliates being classified as a
current receivable or payable, as appropriate. At April 29, 2006, Retail Ventures owned
approximately 63.1% of DSWs outstanding Common Shares, representing approximately 93.2% of
the combined voting power of DSWs outstanding Common Shares. |
3. BASIS OF PRESENTATION
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The accompanying unaudited interim financial statements should be read in conjunction with the
Companys Annual Report on Form 10-K as filed with the Securities and Exchange Commission
(SEC) on April 13, 2006 (the 2005 Annual Report). |
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|
In the opinion of management, the unaudited interim financial statements reflect all
adjustments, consisting of normal recurring adjustments, which are necessary to present fairly
the consolidated financial position and results of operations for the periods presented. |
4. ADOPTION OF ACCOUNTING STANDARDS
|
|
The Financial Accounting Standards Board (FASB) periodically issues Statements of Financial
Accounting Standards (SFAS), some of which require implementation by a date falling within
or after the close of the fiscal year. |
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|
|
In December 2004, the FASB issued SFAS No. 123 (revised 2004) Share-Based Payment (SFAS No.
123R). This statement revised SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS
No. 123) and requires a fair value measurement of all stock-based payments to employees,
including grants of employee stock options, and recognition of those expenses in the
statements of operations. SFAS No. 123R establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods and services and
focuses on accounting for transactions in which an entity obtains employee services in
share-based payment transactions. In addition, SFAS No. 123R requires the recognition of
compensation expense over the period during which an employee is required to provide service
in exchange for an award. The effective date of this standard was originally established to
be interim and annual periods beginning after June 15, 2005. |
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In April 2005, the SEC delayed the compliance date for SFAS No. 123R until the beginning of
DSWs 2006 fiscal year. Effective January 29, 2006, the Company adopted SFAS No. 123R. The
impact of adoption to the Companys results of operations is presented in Note 5. |
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|
FASB Statement No. 154, Accounting Changes and Error Corrections a replacement of APB
Opinion No. 20 and FASB Statement No. 3 (SFAS
No. 154) was issued in May 2005. SFAS
No. 154 changes the requirements for the accounting for and reporting of a change in
accounting principle. SFAS No. 154 is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. The adoption of this new |
-8-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
pronouncement in fiscal 2006 was not material to the Companys financial condition, results of
operations or cash flows. |
5. STOCK BASED COMPENSATION
|
|
The Company has a 2005 Equity Incentive Plan that provides for the issuance of equity awards
to purchase up to 4,600,000 common shares, including stock options and restricted stock units
to management, key employees of the Company and affiliates,
consultants (as defined in the plan), and
directors of the Company. Options generally vest 20% per year on a cumulative basis. Options
granted under the 2005 Equity Incentive Plan generally remain exercisable for a period of ten
years from the date of grant. Prior to fiscal 2005, the Company did not have a stock option
plan or any equity units outstanding. |
|
|
|
On January 29, 2006, DSW adopted the fair value recognition provisions of Financial Accounting
Standards Board (FASB) SFAS No. 123R relating to its stock-based compensation plans. Prior to
January 29, 2006, DSW had accounted for stock-based compensation in accordance with APB No.
25, Accounting for Stock Issued to Employees, and related interpretations. In accordance with
APB 25, compensation expense for employee stock options was generally not recognized for
options granted that had an exercise price equal to the market value of the underlying common
shares on the date of grant. |
|
|
|
Under the modified prospective method of SFAS No. 123R, compensation expense was recognized
during the three months ended April 29, 2006, for all unvested stock options, based on the
grant date fair value estimated in accordance with the original provisions of SFAS No. 123,
and for all stock based payments granted after January 29, 2006, based on the grant date fair
value estimated in accordance with the provisions of SFAS No. 123R. Stock-based compensation
expense was recorded in operating expenses in the condensed consolidated statement of income.
The Companys financial results for the prior periods have not been restated. |
|
|
|
During the three months ended April 29, 2006, the Company recorded stock based compensation
expense of approximately $0.7 million. |
|
|
|
Prior to the adoption of SFAS No. 123R, the Company presented all tax benefits of deductions
resulting from the exercise of stock options as operating cash flows in the condensed
consolidated statement of cash flows. SFAS No. 123R requires the cash flows resulting from
the tax benefits resulting from tax deductions in excess of compensation expense recognized
for those options (excess tax benefits) to be classified as financing cash flows. |
|
|
|
Consistent with the valuation method used for the disclosure only provisions of SFAS No. 123,
the Company uses the Black-Scholes option-pricing model to value stock-based compensation
expense. This model assumes that the estimated fair value of options is amortized over the
options vesting periods and the compensation costs would be included in operating expenses in
the condensed consolidated statement of income. |
-9-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
Stock Options |
|
|
|
Forfeitures are estimated at the grant date based on historical rates of the parent companys
stock option activity and reduce the compensation expense recognized. The expected term of
options granted is derived from historical data of the parent companys stock options due to
the limited historical data on the DSW stock activity and was five years for the three months
ended April 29, 2006. The risk-free interest rate is based on the yield for U.S. Treasury
securities with a remaining life equal to the five year expected term of the options at the
grant date. Expected volatility is based on the historical volatility of the DSW common
shares combined with the historical volatility of four similar companies common shares, due
to the relative short historical trading history of the DSW common shares. The expected
volatility used for the three months ended April 29, 2006 was
42.62%. The expected dividend
yield curve is zero, which is based on the Companys intention of not declaring dividends to
shareholders combined with the limitations on declaring dividends as
set forth in the Companys
credit facility. |
|
|
|
The weighted-average fair value of each option granted for the three months ended April 29,
2006 was $13.24 per share. |
|
|
|
The following table summarizes the Companys stock option plans and related Weighted Average
Exercise Prices (WAEP) for the three months ended
April 29, 2006 (in thousands, except WAEP amounts): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
Aggregate |
|
|
|
|
|
|
|
|
|
|
|
Remaining |
|
|
Intrinsic |
|
|
|
Shares |
|
|
WAEP |
|
|
Contract Life |
|
|
Value |
|
Outstanding beginning of period |
|
|
914 |
|
|
$ |
19.54 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
107 |
|
|
|
29.76 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(8 |
) |
|
|
19.00 |
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(36 |
) |
|
|
19.00 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding end of period |
|
|
977 |
|
|
$ |
20.68 |
|
|
9 years |
|
$ |
10,380 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable end of period |
|
|
44 |
|
|
$ |
19.00 |
|
|
9 years |
|
$ |
541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares available for additional grants |
|
|
3,465 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value is calculated as the amount by which the fair value of the
underlying common shares exceeds the option exercise price. The total intrinsic value of
options exercised during the three months ended April 29, 2006 was $0.1 million. |
-10-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
As of April 29, 2006, the total compensation cost related to nonvested options not yet
recognized was approximately $3.1 million with a weighted average expense recognition period
remaining of 4.3 years. The total fair value of options that vested during the three months
ended April 29, 2006 was $0.2 million. |
|
|
The following table summarizes information about options outstanding as of April 29, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract |
|
|
|
|
|
Options Exercisable |
Range of Exercise Prices |
|
Shares |
|
Life |
|
WAEP |
|
Shares |
|
WAEP |
|
|
$ |
19.00 |
|
|
|
|
|
|
$ |
20.00 |
|
|
|
785,900 |
|
|
9 years |
|
$ |
19.00 |
|
|
|
44,000 |
|
|
$ |
19.00 |
|
|
|
$ |
20.01 |
|
|
|
|
|
|
$ |
25.00 |
|
|
|
73,300 |
|
|
10 years |
|
$ |
24.52 |
|
|
|
|
|
|
|
|
|
|
|
$ |
25.01 |
|
|
|
|
|
|
$ |
30.00 |
|
|
|
56,300 |
|
|
10 years |
|
$ |
27.57 |
|
|
|
|
|
|
|
|
|
|
|
$ |
30.01 |
|
|
|
|
|
|
$ |
32.00 |
|
|
|
61,900 |
|
|
10 years |
|
$ |
31.21 |
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Units |
|
|
|
The Company granted approximately 131,000 restricted stock units to employees during fiscal
2005. Restricted stock units generally cliff vest at the end of four years and expire ten
years from the grant date. Restricted stock units granted to employees that are subject to the
risk of forfeiture are not included in the computation of basic earnings per share. |
|
|
|
Compensation cost is measured at fair value on the grant date and recorded over the vesting
period. Fair value is determined by multiplying the number of units granted by the grant date
market price. DSW did not award any restricted stock units during the three months ended
April 29, 2006 and no restricted stock units vested or were forfeited during the quarter. The
weighted average fair value of the nonvested restricted stock units at the beginning and the
end of the period was $20.46 per unit. The total aggregate intrinsic value of nonvested restricted
stock units at April 29, 2006 was $4.1 million and the weighted average remaining contractual
life was nine years. As of April 29, 2006, the total compensation cost related to nonvested
restricted stock units not yet recognized was approximately $2.2 million with a weighted
average expense recognition period remaining of 3.0 years. |
|
|
|
Director Stock Units |
|
|
|
In 2005, the Company issued approximately 17,000 stock units to directors who are not
employees of the Company or Retail Ventures. Stock units will be automatically granted to each
director who is not an employee of the Company or Retail Ventures on the date of each annual
meeting of the shareholders for the purpose of electing directors. The number of stock units
granted to each non-employee director is calculated by dividing one-half of their annual
retainer (excluding any amount paid for service as the chair of a board committee) by the fair |
-11-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
market value of a share of DSW stock on the date of the meeting. In addition, each director
eligible to receive compensation for board service may elect to have the cash portion of their
compensation paid in the form of restricted stock units. Stock units granted to non-employee
directors vest immediately and are settled upon the director terminating service from the board. Stock
units granted to directors which are not subject to forfeiture are considered to be
outstanding for the purposes of computing basic earnings per share. |
6. EARNINGS PER SHARE
|
|
Basic earnings per share are based on net income and a simple weighted average of Class A and
Class B Common Shares and directors stock units outstanding. Diluted earnings per share
reflect the potential dilution of Class A Common Shares related to outstanding stock options
and restricted stock units. The numerator for the diluted earnings per share calculation is
net income. The denominator is the weighted average diluted shares outstanding. |
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
April 29, |
|
April 30, |
|
|
2006 |
|
2005 |
|
|
|
(in thousands) |
Weighted average shares outstanding |
|
|
43,896 |
|
|
|
27,703 |
|
Assumed exercise of dilutive stock options |
|
|
117 |
|
|
|
|
|
Assumed exercise of dilutive restricted stock units |
|
|
131 |
|
|
|
|
|
|
Number of shares for computation of
dilutive earnings per share |
|
|
44,144 |
|
|
|
27,703 |
|
|
|
|
For the three months ended April 29, 2006, all potentially dilutive stock options were
dilutive. For the three months ended April 30, 2005, there were no potentially dilutive
instruments outstanding. |
|
7. |
|
LONG-TERM OBLIGATIONS |
|
|
|
DSW $150 Million Credit Facility |
|
|
|
In July 2005, upon the consummation of DSWs IPO, RVI and the lenders thereunder amended or
terminated the existing credit facilities and other debt obligations of Value City and its
other affiliates, including certain facilities under which DSW had rights and obligations as a
co-borrower and co-guarantor and released DSW and DSWSW from their obligations as co-borrowers
and co-guarantors. At the same time, DSW entered into a new $150 million secured revolving
credit facility with a term of five years. |
|
|
|
Under this new facility, DSW and DSWSW are named as co-borrowers. The new secured revolving
credit facility has borrowing base restrictions and provides for borrowings at variable
interest rates based on London Interbank Offered Rate
(LIBOR), the prime rate and the Federal Funds effective rate, plus a
margin. DSWs obligations under its new secured revolving credit facility are collateralized
by a lien on substantially all of DSWs and its subsidiarys personal property |
-12-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
and a pledge of
all of its shares of DSWSW. In addition, this facility contains usual and customary
restrictive covenants relating to DSWs management and the operation of its business. These
covenants, among other things, restrict DSWs ability to grant liens on its assets, incur
additional indebtedness, open or close stores, pay cash dividends and redeem its stock, enter
into transactions with affiliates and merge or consolidate with another entity. In addition,
if at any time DSW utilizes over 90% of its borrowing capacity under this facility, it
must comply with a fixed charge coverage ratio test set forth in the facility documents. At
April 29, 2006 and January 28, 2006, DSW had no balance outstanding and was in compliance with
the terms of the secured revolving credit facility. |
|
|
|
Credit Facilities Under Which DSW is No Longer Obligated |
|
|
|
In March 2005, DSW and RVI and certain of their affiliates increased the ceiling under their
then-existing revolving credit facility from $350 million to $425 million. The increase of $75
million to the revolving credit facility was accomplished by amendment under substantially the
same terms as the then-existing revolving credit agreement. |
|
|
|
In March 2005, DSW declared a dividend and issued an intercompany note to RVI in the amount of
$165 million. The indebtedness evidenced by this note was scheduled to mature in March 2020
and bore interest at a rate equal to LIBOR, plus 850 basis
points per year. |
|
|
|
In May 2005, DSW declared an additional dividend and issued an intercompany note to RVI in the
amount of $25 million. The indebtedness evidenced by this note was scheduled to mature in May
2020 and bore interest at a rate equal to LIBOR, plus 950 basis points per year. |
|
|
|
In July 2005, subsequent to the IPO, DSW prepaid in full, without penalty, the principal
balance of both the $165 million and $25 million dividend notes, plus accrued interest of
approximately $6.6 million. |
8. SEGMENT REPORTING
|
|
The Company is managed in two operating segments: DSW owned stores and leased departments. All
of the operations are located in the United States. The Company has identified such segments
based on internal management reporting and management responsibilities and measures segment
profit as gross profit, which is defined as net sales less cost of sales. The tables below
present segment information: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DSW |
|
|
Leased |
|
|
|
|
|
|
Stores |
|
|
Departments |
|
|
Total |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Three months ended April 29, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
283,813 |
|
|
$ |
32,674 |
|
|
$ |
316,487 |
|
Gross profit |
|
|
87,187 |
|
|
|
6,100 |
|
|
|
93,287 |
|
Capital expenditures |
|
|
4,115 |
|
|
|
117 |
|
|
|
4,232 |
|
|
As of April 29, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
|
521,873 |
|
|
|
26,601 |
|
|
|
548,474 |
|
-13-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DSW |
|
|
Leased |
|
|
|
|
|
|
Stores |
|
|
Departments |
|
|
Total |
|
|
|
(in thousands) |
|
Three months ended April 30, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
251,310 |
|
|
$ |
30,496 |
|
|
$ |
281,806 |
|
Gross profit |
|
|
77,743 |
|
|
|
5,055 |
|
|
|
82,798 |
|
Capital expenditures |
|
|
5,465 |
|
|
|
114 |
|
|
|
5,579 |
|
|
As of January 28, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
|
479,364 |
|
|
|
28,351 |
|
|
|
507,715 |
|
9. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
|
April 29, |
|
|
April 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(in thousands) |
|
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Interest to non-related parties |
|
$ |
5 |
|
|
$ |
1,021 |
|
Income taxes |
|
$ |
2,605 |
|
|
$ |
494 |
|
|
|
|
|
|
|
|
|
|
Noncash investing and operating activities
Changes in accounts payable due to
asset purchases |
|
$ |
340 |
|
|
$ |
264 |
|
10. COMMITMENTS AND CONTINGENCIES
|
|
As previously reported, on March 8, 2005 RVI announced that it had learned of the theft of
credit card and other purchase information from a portion of the Companys customers. On April
18, 2005, RVI issued the findings from its investigation into the theft. The theft covered
transaction information involving approximately 1.4 million credit cards and data from
transactions involving approximately 96,000 checks. |
|
|
|
DSW and RVI contacted and continue to cooperate with law enforcement and other authorities
with regard to this matter. The Company is involved in several legal proceedings arising out
of this incident, including four putative class action lawsuits, which seek unspecified
monetary damages, credit monitoring and other relief. |
-14-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
In connection with this matter, DSW entered into a consent order with the Federal Trade
Commission, (FTC), which has jurisdiction over consumer protection matters. The FTC
published the final order on March 14, 2006, and copies of the complaint and consent order are
available from the FTCs Web site at http://www.ftc.gov and also from the FTCs Consumer
Response Center, Room 130, 600 Pennsylvania Avenue, N.W., Washington, D.C. 20580.
|
|
|
|
DSW has not
admitted any wrongdoing or that the facts alleged in the FTCs proposed unfairness complaint
are true. Under the consent order, DSW will pay no fine or
damages. DSW has agreed, however, to maintain a comprehensive information security program
and to undergo a biannual assessment of such program by an independent third party. |
|
|
|
There can be no assurance that there will not be additional proceedings or claims brought
against the Company in the future. The Company has contested and will continue to vigorously
contest the claims made against it and will continue to explore its defenses and possible
claims against others. |
|
|
|
The Company estimates that the potential exposure for losses related to this theft, including
exposure under currently pending proceedings, range from approximately $6.5 million to
approximately $9.5 million. Because of many factors, including the early development of
information regarding the theft and recoverability under insurance policies, there is no
amount in the estimated range that represents a better estimate than any other amount in the
range. Therefore, in accordance with Financial Accounting Standard No. 5, Accounting for
Contingencies, the Company has accrued a charge to operations in the first quarter of fiscal
2005 equal to the low end of the range set forth above, or $6.5 million. As the situation
develops and more information becomes available, the amount of the reserve may increase or
decrease accordingly. The amount of any such change may be material.
As of April 29,
2006, the remaining balance of the associated accrual for potential
exposure was $4.6 million. |
|
|
|
Although difficult to quantify, since the announcement of the theft, the Company has not
discerned any material negative effect on sales trends it believes is attributable to the
theft. However, this may not be indicative of the long-term developments regarding this
matter. |
|
|
|
The Company is involved in various other legal proceedings that are incidental to the conduct
of its business. The Company estimates the range of liability related to pending litigation
where the amount and range of loss can be estimated. The Company records its best estimate of
a loss when the loss is considered probable. Where a liability is probable and there is a
range of estimated loss, the Company records the minimum estimated liability related to the
claim. In the opinion of management, the amount of any liability with respect to these legal
proceedings will not be material. As additional information becomes available, the Company
assesses the potential liability related to its pending litigation and revises the estimates.
Revisions in the Companys estimates and potential liability could materially impact its
results of operations and financial condition. |
-15-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
11. SUBSEQUENT EVENT
|
|
On May 30, 2006, the Company entered into an Amended and Restated Supply Agreement (the
Agreement) to supply shoes to Stein Mart. Under the terms of the
Agreement, the Company will be the exclusive supplier of shoes (the Merchandise) to all
Stein Mart stores that have shoe departments. As of April 29, 2006, the Company supplied
Merchandise to 158 Stein Mart stores. The Company will own the Merchandise until the
Merchandise is sold to the customer. The Company will receive a
percentage of the net revenue
generated from the sale of the Merchandise consistent with the previous agreement as now amended. The
Agreement terminates on December 31, 2009, but will automatically extend for another three
years in the event that neither party gives notice of its intent not to renew. |
-16-
Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations.
As used in this Quarterly Report on Form 10-Q (this Report) and except as the context otherwise
may require, Company, we, us, and our refers to DSW Inc. (DSW) and its wholly owned
subsidiary, DSW Shoe Warehouse, Inc. (DSWSW).
Company Overview
DSW is a leading U.S. specialty branded footwear retailer operating 204 DSW stores in 33 states as
of April 29, 2006. We offer in our DSW stores a combination of selection, convenience and value
that we believe differentiates us from our competitors such as mall-based department stores,
national chains and independent shoe retailers and appeals to consumers from a broad range of
socioeconomic and demographic backgrounds. In addition to operating DSW stores, as of April 29,
2006, we operated a total of 216 leased shoe departments for three non-affiliated retailers,
including 158 leased shoe departments for Stein Mart, Inc. (Stein Mart); 57 for Gordmans, Inc.
(Gordmans); and one for Frugal Fannies Fashion Warehouse (Frugal Fannies). As of April 29,
2006, we also operated 25 leased shoe departments for Filenes Basement, a wholly-owned subsidiary
of Retail Ventures. We plan to further strengthen our position as a leading specialty branded
footwear retailer by pursuing three primary strategies for growth expanding our store base,
driving sales through enhanced merchandising and continuing to improve profitability.
Forward-Looking Statements
Some of the statements in this Managements Discussion and Analysis of Financial Condition and
Results of Operations, and elsewhere in this Quarterly Report on Form 10-Q, including information
incorporated by reference herein, may contain forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which reflect
our current views with respect to, among other things, future events and financial performance. You
can identify these forward-looking statements by the use of forward-looking words such as
outlook, believes, expects, potential, continues, may, will, should, seeks,
approximately, predicts, intends, plans, estimates, anticipates or the negative version
of those words or other comparable words. Any forward-looking statements contained in this
Quarterly Report on Form 10-Q are based upon our historical performance and on current plans,
estimates and expectations. The inclusion of this forward-looking information should not be
regarded as a representation by us, or any other person that the future plans, estimates or
expectations contemplated by us will be achieved. Such forward-looking statements are subject to
various risks and uncertainties. Accordingly, there are or will be important factors that could
cause our actual results to differ materially from those indicated in these statements. We believe
that these factors include but are not limited to those described under Risk Factors in our
Annual Report on Form 10-K, as supplemented by Item 1A, Part II of this Report. These factors
should not be construed as exhaustive and should be read in conjunction with the other cautionary
statements that are included in this Report. We do not undertake any obligation to publicly update
or review any forward-looking statement, whether as a result of new information, future
developments or otherwise.
If one or more of these or other risks or uncertainties materialize, or if our underlying
assumptions prove to be incorrect, actual results may vary materially from what we may have
projected. Any forward-looking statements you read in this Quarterly Report on Form 10-Q reflect
our current views with respect to future events and are subject to these and other risks,
uncertainties and assumptions relating to our operations, results of operations, financial
condition, growth strategy and liquidity.
Critical Accounting Policies
The preparation of our consolidated financial statements in conformity with generally accepted
accounting principles, or GAAP, requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of commitments and contingencies at
the date of the financial statements and reported amounts of revenues and expenses during the
reporting period. On an ongoing basis, we evaluate our estimates and judgments, including, but not
limited to, those related to inventory valuation, depreciation, amortization, recoverability of
long-lived assets (including intangible assets), estimates for self insurance reserves for health
and welfare, workers compensation and casualty insurance,
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customer loyalty program, income taxes,
contingencies, litigation and revenue recognition. We base these estimates and judgments on our
historical experience and other factors we believe to be relevant, the results of which form the
basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. The process of
determining significant estimates is fact-specific and takes into account factors such as
historical experience, current and expected economic conditions, product mix, and in some cases,
actuarial and appraisal techniques. We constantly re-evaluate these significant factors and make
adjustments where facts and circumstances dictate.
While we believe that our historical experience and other factors considered provide a meaningful
basis for the accounting policies applied in the preparation of the consolidated statements, we
cannot guarantee that our estimates and assumptions will be accurate. As the determination of
these estimates requires the exercise of judgment, actual results inevitably will differ from those
estimates, and such differences may be material to our financial statements.
We believe the following represent the most significant accounting policies, critical estimates and
assumptions, among others, used in the preparation of our consolidated financial statements:
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Revenue Recognition. Revenues from merchandise sales are recognized at the point of
sale and are net of returns and exclude sales tax. Revenue from gift cards is deferred and
the revenue is recognized upon redemption of the gift cards. |
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Cost of Sales and Merchandise Inventories. Merchandise inventories are stated at the
lower of cost, determined using the first-in, first-out basis, or market, using the retail
inventory method. The retail inventory method is widely used in the retail industry due to
its practicality. Under the retail inventory method, the valuation of inventories at cost
and the resulting gross profit are calculated by applying a calculated cost to retail ratio
to the retail value of inventories. The cost of the inventory reflected on our
consolidated balance sheet is decreased by charges to cost of sales at the time the retail
value of the inventory is lowered through the use of markdowns. Hence, earnings are
negatively impacted as merchandise is marked down prior to sale. Reserves to value
inventory at the lower of cost or market were $19.6 million on April 29, 2006 and $19.2
million at January 28, 2006. |
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Inherent in the calculation of inventories are certain significant management judgments and
estimates, including setting the original merchandise retail value or mark-on, markups of
initial prices established, reductions in prices due to customers perception of value (known
as markdowns), and estimates of losses between physical inventory counts, or shrinkage,
which, combined with the averaging process within the retail inventory method, can
significantly impact the ending inventory valuation at cost and the resulting gross profit. |
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We include in the cost of sales expenses associated with warehousing, distribution and store
occupancy. Warehousing costs are comprised of labor, benefits and other labor-related costs
associated with the operations of the warehouse, which are primarily payroll-related taxes
and benefits. The non-labor costs associated with warehousing include rent, depreciation,
insurance, utilities and maintenance and other operating costs that are passed to us from the
landlord. Distribution costs include the transportation of merchandise to the warehouse and
from the warehouse to our stores. Store occupancy costs include rent, utilities, repairs,
maintenance, insurance and janitorial costs and other costs associated with |
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licenses and
occupancy-related taxes, which are primarily real estate taxes passed to us by our landlords. |
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Asset Impairment and Long-lived Assets. We must periodically evaluate the carrying
amount of our long-lived assets, primarily property and equipment, and finite life
intangible assets when events and circumstances warrant such a review to ascertain if any
assets
have been impaired. The carrying amount of a long-lived asset is considered impaired when
the carrying value of the asset exceeds the expected future cash flows from the asset. Our
reviews are conducted at the lowest identifiable level, which includes a store. The
impairment loss recognized is the excess of the carrying amount of the asset over its fair
value, estimated on discounted cash flow. Should an impairment loss be realized, it will be
included in cost of sales. The amount of impairment losses recorded in fiscal 2005 was $0.2
million, all of which was recorded in the fourth quarter. No impairment losses have been
recorded during the three months ended April 29, 2006. |
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We believe at this time that the long-lived assets carrying values and useful lives continue
to be appropriate. To the extent these future projections or our strategies change, our
conclusion regarding asset impairment may differ from our current estimates. |
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Self-insurance Reserves. We record estimates for certain health and welfare, workers
compensation and casualty insurance costs that are self-insured programs. These estimates
are based on actuarial assumptions and are subject to change based on actual results.
Should the total cost of claims for health and welfare, workers compensation and casualty
insurance exceed those anticipated, reserves recorded may not be sufficient, and, to the
extent actual results vary from assumptions, earnings would be impacted. |
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Customer Loyalty Program. We maintain a customer loyalty program for our DSW stores in
which customers receive a future discount on qualifying purchases. The Reward Your Style
program is designed to promote customer awareness and loyalty and provide us with the
ability to communicate with our customers and enhance our understanding of their spending
trends. Upon reaching the target spending level, customers may redeem these discounts on a
future purchase. Generally, these future discounts must be redeemed within six months. We
accrue the estimated costs of the anticipated redemptions of the discount earned at the
time of the initial purchase and charge such costs to operating expense based on historical
experience. The estimates of the costs associated with the loyalty program require us to
make assumptions related to customer purchase levels and redemption rates. The accrued
liability as of April 29, 2006 and January 28, 2006 was $10.2 million and $8.3 million,
respectively. To the extent assumptions of purchases and redemption rates vary from actual
results, earnings would be impacted. |
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Income Taxes. We are required to determine the aggregate amount of income tax expense
to accrue and the amount which will be currently payable based upon tax statutes of each
jurisdiction we do business in. In making these estimates, we adjust income based on a
determination of generally accepted accounting principles for items that are treated
differently by the applicable taxing authorities. Deferred tax assets and liabilities, as
a result of these differences, are reflected on our balance sheet for temporary differences
that will reverse in subsequent years. A valuation allowance is established against
deferred tax assets when it is more likely than not that some or all of the deferred tax
assets will not be |
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realized. If management had made these determinations on a different
basis, our tax expense, assets and liabilities could be
different.
Results of Operations
As of April 29, 2006, we operated 204 DSW stores in 33 states, and leased shoe departments in 158
Stein Mart stores, 57 Gordmans stores, 25 Filenes Basement stores and one Frugal Fannies store.
We manage our operations in two segments, defined as DSW stores and leased departments. The leased
departments are comprised of leased shoe departments in Stein Mart,
Gordmans, Frugal Fannies and Filenes Basement. The following table represents selected components
of our historical consolidated results of operations, expressed as percentages of net sales:
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Three months ended |
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April 29, |
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April 30, |
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2006 |
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2005 |
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Net sales |
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100.0 |
% |
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100.0 |
% |
Cost of sales |
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(70.5 |
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(70.6 |
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Gross profit |
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29.5 |
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29.4 |
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Operating expenses |
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(20.7 |
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(24.1 |
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Operating profit |
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8.8 |
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5.3 |
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Interest income (expense), net |
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0.4 |
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(1.2 |
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Earnings before income taxes |
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9.2 |
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4.1 |
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Income tax provision |
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(3.7 |
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(1.6 |
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Net income |
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5.5 |
% |
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2.5 |
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THREE MONTHS ENDED April 29, 2006 COMPARED TO THREE MONTHS ENDED
April 30, 2005
Net Sales. Net sales for the thirteen week period ended April 29, 2006 increased by 12.3%, or
$34.7 million, to $316.5 million from $281.8 million in the thirteen week period ended April 30,
2005. Our comparable store sales in the first quarter of fiscal 2006 improved 4.2% compared to the
first quarter of fiscal 2005. The increase in DSW sales includes a net increase of 27 DSW stores
and ten non-affiliated leased shoe departments. The DSW store locations opened subsequent to
April 30, 2005 added $21.1 million in sales for the quarter
ended April 29, 2006, while the leased shoe departments opened subsequent to
April 30, 2005 added $1.0 million for the quarter ended
April 29, 2006. Leased shoe department sales comprised 10.3% of total net sales
in the first quarter of fiscal 2006, compared to 10.8% in the first quarter of fiscal 2005.
For the first quarter of fiscal 2006, DSW comparable store sales increased in womens by 5.5%,
athletic by 3.2%, mens by 1.7%, and accessories by 3.1%. Sales increases in the womens category
were driven by increases in the seasonal classes, while the increase in the athletic category was
the result of an increase in the womens and mens fashion classes. The increase in mens was
driven by the young mens class. The increase in the accessories category was driven by an
increase in gifts.
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Gross Profit. Gross profit increased $10.5 million to $93.3 million in the first quarter of fiscal
2006 from $82.8 million in the first quarter of fiscal 2005, and increased as a percentage of net
sales from 29.4% in the first quarter of fiscal 2005 to 29.5% in the first quarter of fiscal 2006.
The margin for the first quarter of fiscal 2006 was positively affected by an increased initial
markup, a reduction of the internal shrink accrual rate to the comparable prior year period and
decreased warehouse expense. Those positive factors were mostly offset by an increase in markdowns
and increase in occupancy expense. The store occupancy expense increased from 12.6% of net sales
in the first quarter of fiscal 2005 to 12.9% of net sales in the first quarter of fiscal 2006. The
increase in store occupancy expense is the result of increases in lease expense for new stores.
Warehouse expense as a percentage of net sales decreased from 1.7% in the first quarter of fiscal
2005 to 1.1% in the first quarter of fiscal 2006. The decrease in warehouse expense is the result
of improved operational efficiencies achieved through the use of electronic shipping information
and increased unit volumes.
Operating Expenses. For the first quarter of fiscal 2006, operating expenses decreased $2.3
million to $65.4 million from $67.7 million in the first quarter of fiscal 2005, which represented
20.7% and 24.1% of net sales, respectively. The favorable operating
percent was in part the result of
leveraging store expenses and marketing, and a reduction in
pre-opening costs. In addition, operating costs for
the first quarter of fiscal 2005 included a charge of $6.5 million related to an estimate for
potential losses related to the theft of credit card and other purchase information. Operating
expenses for the first quarter of fiscal 2006 include $0.9 million in pre-opening costs compared to
$1.5 million in pre-opening costs in the first quarter of fiscal 2005. Pre-opening costs are
expensed as incurred and therefore do not necessarily reflect expenses for the stores opened in a
given fiscal period. Included in operating expenses is the related operating cost, excluding
occupancy, associated with operating the leased shoe departments. The DSW stores and leased shoe
departments that opened subsequent to April 30, 2005 added $3.4 million in expenses compared to the
first quarter of fiscal 2005, excluding pre-opening and occupancy (excluding depreciation and
amortization) expenses.
Operating Profit. Operating profit was $27.9 million in the first quarter of fiscal 2006 compared
to $15.1 million in the first quarter of fiscal 2005, and increased as a percentage of net sales
from 5.3% in the first quarter of fiscal 2005 to 8.8% in the first quarter of fiscal 2006.
Operating profit as a percentage of net sales was impacted by the leveraging of operating expenses
and the estimate for potential losses related to the theft of credit card and other purchase
information that was incurred in the prior fiscal year.
Interest Income (Expense). Interest income for the first quarter of fiscal 2006 was $1.3 million
as compared to $3.5 million of interest expense for the first quarter of fiscal 2005. Interest
income for the quarter was the result of investment activity from funds generated by the IPO and
from operations. The interest expense incurred in the first quarter of fiscal 2005 includes $2.7
million of interest due to RVI relating to $165.0 million of indebtedness incurred to fund a
dividend and $0.7 million of interest on direct borrowings under the Value City Revolving Credit
Facility.
Income Taxes. Our effective tax rate for the first quarter of fiscal 2006 was 40.0%, compared to
39.5% for the first quarter of fiscal 2005.
Net Income. For the first quarter of fiscal 2006, net income increased $10.5 million, or 151.0%,
over the first quarter of fiscal 2005 and represented 5.5% and 2.5% of net sales, respectively.
This increase was primarily the result of the decrease in operating expenses due to the leveraging
of
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operating expenses and the $6.5 million charge in the prior fiscal year for estimated potential
losses related to the theft of credit card and other purchase information and the interest income
during the period as opposed to having interest expense in the prior fiscal year.
Seasonality
Our business, measured in terms of net sales, is subject to seasonal trends. Our net sales,
measured on a comparable stores basis, have typically been higher in spring and early fall, when
our customers interest in new seasonal styles increases. Unlike many other retailers, we have not
historically experienced a large increase in net sales during our fourth quarter associated with
the winter holiday season.
Liquidity and Capital Resources
Our primary ongoing cash requirements are for seasonal and new store inventory purchases, capital
expenditures in connection with our expansion, the remodeling of existing stores and infrastructure
growth. Since our IPO in July 2005, we have funded our expenditures with cash flows from
operations. Prior to the IPO, we funded our expenditures with cash flows from operations and
borrowings under the Value City credit facilities to which we had been a party, as described
below. Our working capital and inventory levels typically build seasonally. We believe that we
will be able to continue to fund our operating requirements and the expansion of our business
pursuant to our growth strategy in the future with existing cash, cash flows from operations and
borrowings under the DSW secured revolving credit facility, if necessary.
For the thirteen week period ended April 29, 2006, our net cash provided by operations was $38.2
million, compared to $25.8 million provided by operations for the thirteen week period ended April
30, 2005. The $12.4 million increase in cash provided by operations over the comparable period is
primarily due to increased net income and an increase in accounts payable partially offset by an
increase in inventory.
Net working capital increased $19.9 million to $258.4 million at April 29, 2006 from $238.5 million
at January 28, 2006, primarily due to increased cash and inventory related to new stores opened in
fiscal 2006. Current assets divided by current liabilities at April 29, 2006 and January 28, 2006
were 2.6 and 2.7, respectively.
Our future capital expenditures will depend primarily on the number of new stores we open, the
number of existing stores we remodel and the timing of these expenditures. In fiscal 2005, we
opened 29 new DSW stores. We plan to open approximately 30 stores per year in each of the next
four fiscal years. During fiscal 2005, the average investment required to open a typical new DSW
store was approximately $1.4 million. Of this amount, gross inventory typically accounted for
approximately $680,000, fixtures and leasehold improvements typically accounted for approximately
$460,000 (prior to tenant allowances) and pre-opening advertising and other pre-opening expenses
typically accounted for approximately $280,000. We plan to finance investment in new stores with
existing cash and cash flows from operating activities.
$150 Million Secured Revolving Credit Facility. Simultaneously with the amendment and restatement
of the Value City revolving credit facility described below, DSW entered into a new $150 million
secured revolving credit facility with a term of five years. Under this facility, we and our
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subsidiary, DSWSW, are named as co-borrowers. The DSW facility has borrowing base restrictions and
provides for borrowings at variable interest rates based on LIBOR, the prime rate and the Federal
Funds effective rate, plus a margin. Our obligations under the secured revolving credit facility
are secured by a lien on substantially all of our and our subsidiarys personal property and a
pledge of our shares of DSWSW. In addition, our secured revolving credit facility contains usual
and customary restrictive covenants relating to our management and the operation of our business.
These covenants will, among other things, restrict our ability to grant liens on our assets, incur
additional indebtedness, open or close stores, pay cash dividends and redeem our stock, enter into
transactions with affiliates and merge or consolidate with another entity. In addition, if at any
time we utilize over 90% of our borrowing capacity under this facility, we must comply with a fixed
charge coverage ratio test set forth in the facility documents. At April 29, 2006 and January 28,
2006, $141.0 and $136.4 million was available under the $150 million secured revolving credit
facility and no direct borrowings were outstanding. At April 29, 2006 and January 28, 2006, $9.0
and $13.6 million in letters of credit were issued and outstanding.
Transactions with Retail Ventures
Union Square Store Guaranty by Retail Ventures. In January 2004, we entered into a lease agreement
with 40 East 14 Realty Associates, L.L.C., an unrelated third party, for our Union Square store in
Manhattan, New York. In connection with the lease, Retail Ventures has agreed to guarantee payment
of our rent and other expenses and charges and the performance of our other obligations.
Intercompany Accounts. Prior to the completion of our initial public offering in July 2005, DSW and
Retail Ventures used intercompany transactions in the conduct of their operations. Under this
arrangement, Retail Ventures acted as a central processing location for payments for the
acquisition of merchandise, payroll, outside services, capital additions and expenses by
controlling the payroll and accounts payable activities for all Retail Ventures subsidiaries,
including DSW. DSW transferred cash received from sales of merchandise to cash accounts controlled
by Retail Ventures. The concentration of cash and the offsetting payments for merchandise,
expenses, capital assets and accruals for future payments were accumulated on our balance sheet in
advances to affiliates. The balance of advances to affiliates fluctuated based on DSWs activities
with Retail Ventures.
Following completion of our initial public offering, DSWs intercompany
activities have been limited to
those arrangements set forth in the shared services agreement and the other agreements between DSW
and Retail Ventures. DSW no longer concentrates its cash from the sale of merchandise into Retail
Ventures accounts but into its own DSW accounts. DSW pays for its own merchandise, expenses and
capital additions from newly established disbursement accounts. Any intercompany payments are made
pursuant to the terms of the shared services agreement and other agreements between DSW and Retail
Ventures.
The DSW Separation from Retail Ventures
Upon completion of our initial public offering in July 2005, Retail Ventures amended or terminated
the existing credit facilities and other debt obligations of Value City and its other affiliates,
including certain facilities under which DSW had rights and
obligations as a co-borrower and/or
co-guarantor. DSW is no longer a party to any of these agreements.
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The Value City Revolving Credit Facility. Prior to completion of our initial public offering in
July 2005, we were party to a Loan and Security Agreement, as amended, entered into with National
City, as administrative agent, and the other parties named therein, originally entered into in June
2002. Upon the completion of our initial public offering, this revolving credit agreement was
amended and restated and we were released from our obligations as a party thereto.
The Value City Term Loan Facility. Prior to completion of our initial public offering in July 2005,
we were party to a Financing Agreement, as amended, among Cerberus
Partners L.P. (Cerberus),
as agent and lender, and Schottenstein Stores Corporation (SSC) as
lender, and the other parties named as co-borrowers therein, originally entered into in June 2002.
Upon the completion of our initial public offering, this term loan agreement was amended and
restated and we were released from our obligations as a party thereto.
Under the terms of this term loan agreement, SSC and Cerberus each provided us, Value City and the
other Retail Ventures affiliates named as co-borrowers with a separate $50 million term loan
comprised of two tranches with initial three-year terms. In July 2004, the maturity dates of these
loans were extended until June 11, 2006. In connection with the second tranche of these term loans,
Retail Ventures issued to each of Cerberus and SSC warrants to purchase 1,477,396 common shares of
Retail Ventures at a purchase price of $4.50 per share, subject to adjustment. In September 2002,
Back Bay Capital Funding LLC (Back Bay) bought from each of Cerberus and SSC a $1.5 million interest in each of the tranches of
their term loans for an aggregate $6.0 million interest, and Back Bay received from each of
Cerberus and SSC a corresponding portion of the warrants to purchase Retail Ventures common shares
originally issued in connection with the second tranche of their term loans. Effective November 23,
2005, Millennium Partners, L.P. (Millennium) purchased from Back Bay term loan warrants to
purchase an aggregate of 177,288 of Retail Ventures common shares, subject to adjustment. The term
loans stated rate of interest per annum through June 11, 2004 was 14% if paid in cash and 15% if
the co-borrowers elected a paid-in-kind, or PIK, option. During the first two years of the term
loans, the co-borrowers could elect to pay all interest in PIK. During the final two years of the
term loans, the stated rate of interest was 15.0% if paid in cash or 15.5% if by PIK, and the PIK
option was limited to 50% of the interest due. For fiscal 2002 and fiscal 2003, the co-borrowers
elected to pay interest in cash.
In connection with the amendment of this term loan agreement, Retail Ventures amended the
outstanding warrants to provide SSC, Cerberus and Millennium the right, from time to time, in whole
or in part, to (i) acquire Retail Ventures common shares at the then current conversion price
(subject to the anti-dilution provisions), (ii) acquire from Retail Ventures Class A
Common Shares of DSW at an exercise price of $19.00 per share (subject to anti-dilution provisions) or (iii) acquire a combination thereof.
Assuming an exercise price per share of $19.00, SSC and Cerberus would each receive 328,915 Class A
Common Shares, and Millennium would receive 41,989 Class A Common Shares, if they exercised these
warrants in full exclusively for DSW Common Shares. The warrants expire in June 2012. Although
Retail Ventures has informed us that it does not currently intend or plan to undertake a spin-off
of DSW Common Shares to Retail Ventures shareholders (it continues to evaluate financing options in
light of market conditions and other factors), in the event that Retail Ventures effects a spin-off
of its DSW Common Shares to its shareholders in the future, the holders of outstanding unexercised
warrants will receive the same number of DSW Common Shares that they would have received had they
exercised their warrants in full for Retail Ventures common shares immediately prior to the record
date of the spin-off, without regard to any limitations on exercise in
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the warrants. Following the completion of any such spin-off, the warrants will be exercisable
solely for Retail Ventures common shares.
We have entered into an exchange agreement with Retail Ventures whereby, upon the request of Retail
Ventures, we will be required to exchange some or all of the Class B Common Shares of DSW held by
Retail Ventures for Class A Common Shares.
The Value City Senior Subordinated Convertible Loan Facility. Prior to completion of our initial
public offering in July 2005, we were a co-guarantor under the Amended and Restated Senior
Subordinated Convertible Loan Agreement, entered into by Value City, as borrower, Cerberus, as
agent and lender, SSC, as lender, and DSW and the other parties named as guarantors, originally
entered into in June 2002. Upon the completion of our initial public offering, this convertible
loan agreement was amended and restated and we are no longer a party thereto.
In connection with the amendment and restatement of this convertible loan agreement, the $75
million convertible loan was converted into a $50 million non-convertible loan. In addition, Retail
Ventures agreed to issue to SSC and Cerberus convertible warrants which will be exercisable from
time to time until the later of June 11, 2007 and the repayment in full of Value Citys obligations
under the amended and restated loan agreement. Under the convertible warrants, SSC and Cerberus
will have the right, from time to time, in whole or in part, to (i) acquire Retail Ventures common
shares at the conversion price referred to in the convertible loan (subject to antidilution provisions), (ii) acquire from Retail Ventures Class A Common Shares of DSW at an
exercise price of $19.00 per share (subject to antidilution provisions) or (iii) acquire a combination thereof. Although Retail Ventures has informed us
that it does not currently intend or plan to undertake a spin-off of Common Shares to Retail
Ventures shareholders (it continues to evaluate financing options in light of market conditions
and other factors), in the event that Retail Ventures effects a spin-off of its DSW Common Shares
to its shareholders in the future, the holders of outstanding unexercised warrants will receive the
same number of DSW Common Shares that they would have received had they exercised their warrants in
full for Retail Ventures common shares immediately prior to the record date of the spin-off,
without regard to any limitation on exercise contained in the warrants. Following the completion of
any such spin-off, the warrants will be exercisable solely for Retail Ventures common shares.
SSC and
Cerberus may acquire upon exercise of the warrants Class A
Common Shares of DSW from Retail Ventures. As of April 29,
2006, assuming an exercise price per share of $19.00, SSC and Cerberus would receive 1,973,684 and
789,474 Class A Common Shares, respectively, without giving effect to anti-dilution adjustments, if
any, if they exercised these warrants exclusively for DSW Common Shares.
Value City Intercompany Note. The capital stock of DSW held by Retail Ventures secures a $240
million Value City intercompany note made payable by Retail Ventures to Value City, which was
executed and delivered on January 1, 2005 in connection with the transfer of all the capital stock
of DSW and Filenes Basement by Value City to Retail Ventures on that date. The lien granted to
Value City on the DSW capital stock held by Retail Ventures will be released upon written notice
that warrants held by Cerberus, SSC and Millennium are to be exercised in exchange for DSW capital
stock held by Retail Ventures and to be delivered by Retail Ventures upon the exercise of such
warrants. The lien will also be released upon repayment of the note in full.
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The $165.0 Million Intercompany Note. In March 2005, we incurred intercompany indebtedness to fund
a $165.0 million dividend to Retail Ventures. We repaid this note in full in July 2005.
The $25.0 Million Intercompany Note. In May 2005, we incurred intercompany indebtedness to fund a
$25.0 million dividend to Retail Ventures. We repaid this note in full in July 2005.
Cross-Corporate Guarantees. We previously entered into cross-corporate guarantees with various
financing institutions pursuant to which we, Retail Ventures, Filenes Basement and Value City,
jointly and severally, guaranteed payment obligations owed to these entities under factoring
arrangements they had entered into with vendors who provided merchandise to some or all of
Retail Ventures subsidiaries. In July 2005, we terminated these cross-corporate guarantees and no
amounts remain guaranteed by us.
Contractual Obligations
DSW had outstanding letters of credit that totaled approximately $9.0 million at April 29, 2006 and
$13.6 million at January 28, 2006. If certain conditions are met under these arrangements, the
Company would be required to satisfy the obligations in cash. Due to the nature of these
arrangements and based on historical experience, DSW does not expect to make any significant
payment outside of terms set forth in these arrangements.
As of April 29, 2006, we have entered into various construction commitments, including capital
items to be purchased for projects that were under construction, or for which a lease has been
signed. Our obligations under these commitments aggregated to approximately $0.3 million as of
April 29, 2006. In addition, we have signed lease agreements for 20 new store locations with annual
rent of approximately $7.6 million. In connection with the new lease agreements, we will receive
approximately $5.8 million of tenant allowances, which will reimburse us for expenditures at these
locations.
We operate all our stores, warehouses and corporate office space from leased facilities. Lease
obligations are accounted for either as operating leases or as capital leases based on lease by
lease review at lease inception. The Company had no capital leases outstanding as of April 29,
2006.
On July 5, 2005, subsequent to the IPO, we paid in full the principal balance of both the $165 and
$25 million dividend notes plus accrued interest of approximately $6.6 million to RVI, $20 million
outstanding on the Companys old secured revolving credit facility and a $10 million intercompany
advance from RVI used to pay down on the outstanding old credit facility borrowing.
Off-Balance Sheet Arrangements
The Company does not intend to participate in transactions that generate relationships with
unconsolidated entities or financial partnerships, such as special purpose entities or variable
interest entities, which would facilitate off-balance sheet arrangements or other limited purposes.
As of April 29, 2006, the Company has not entered into any off-balance sheet arrangements, as
that term is described by the SEC.
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Proposed Accounting Standards
The Financial Accounting Standards Board (FASB) periodically issues Statements of Financial
Accounting Standards (SFAS), some of which require implementation by a date falling within or
after the close of the fiscal year. See Note 5 to the Condensed
Consolidated Financial Statements for a discussion of the new
accounting standards implemented during the quarter ended April 29,
2006.
An exposure draft of the proposed interpretation of FASB Statement No. 109, Accounting for
Uncertain Tax Provisions, was issued in July 2005. The exposure draft contains proposed guidance
on the recognition and measurement of uncertain tax positions. If adopted as proposed, the Company
would be required to recognize, in its financial statements, the best estimate of the impact of a
tax position, only if that tax position is probable of being sustained on audit based solely on the
technical merits of the position. The proposed effective date for the interpretation was
originally scheduled for December 31, 2005, with a cumulative effect of a change in accounting
principle to be recorded upon the initial adoption. In January 2006, FASB decided to make
forthcoming rules on certain tax positions effective in 2007. FASB also moved to a view that such
recognition should be changed from the tax position being probable of being sustained on audit
based solely on the technical merits of the position to a less stringent benchmark of more
likely than not that the position would be sustained on audit or final resolution through legal
action of settlement. FASB expects to publish the planned rules on uncertain tax positions in
2006. The Company is currently evaluating the impact this proposed interpretation will have on its
consolidated financial statements.
An exposure draft of the proposed amendment to FASB Statement no 132, Employers Accounting for
Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87,
88, 106 and 132R, was issued in March 2006. This Exposure Draft would amend the FASB Statements
No. 87, 88, 106 and 132R. The intent of the Exposure Draft is to require an employer to recognize
as a component of other comprehensive income, net of tax, the actuarial gains and losses and prior
service costs and credits that arise during the period. The comment deadline on this Exposure
Draft is May 31, 2006, with a planned effective date for fiscal years ending after December 31,
2006. The Company does not believe that the impact of this proposed amendment will have a material
effect on its results of operations.
An exposure draft of a proposed SFAS, Fair Value Measurements, was issued in June 2004. This
exposure draft defines fair value, establishes a framework for measuring fair value in GAAP, and
expands disclosures about fair value measurements. The intent of this standard is to ensure
consistency and comparability in fair value measurements and enhanced disclosures regarding the
measurements. FASB expects to issue a final statement by June 30, 2006. The Company is currently
evaluating the impact this exposure draft will have on its consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Our cash and cash equivalents are maintained only with maturities of 90 days or less. Our
short-term investments have interest reset periods of 35 days or less. These financial instruments
may be subject to interest rate risk through lost income should interest rates increase during
their limited term to maturity or resetting of interest rates. As of April 29, 2006 and January 28,
2006, there was no long-term debt outstanding. Future borrowings, if any, would bear interest at
negotiated rates and would be subject to interest rate risk. Because we have no outstanding debt,
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we do not believe that a hypothetical adverse change of 10% in interest rates would have a material
effect on our financial position.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We, under the supervision and with the participation of our management, including the Chief
Executive Officer and Chief Financial Officer, performed an evaluation of our disclosure controls
and procedures, as contemplated by Securities Exchange Act Rules 13a-15(e) and 15d-15(e). Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer concluded, as of the end
of the period covered by this report, that such disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
No change was made in our internal control over financial reporting during our most recent fiscal
quarter that has materially affected, or is reasonable likely to affect, our internal control over
financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
As previously reported, on March 8, 2005, Retail Ventures announced that it had learned of the
theft of credit card and other purchase information from a portion of DSW customers. On April 18,
2005, Retail Ventures issued the findings from its investigation into the theft. The theft covered
transaction information involving approximately 1.4 million credit cards and data from transactions
involving approximately 96,000 checks.
DSW and RVI contacted and continue to cooperate with law enforcement and other authorities with
regard to this matter. DSW is involved in several legal proceedings arising out of this incident,
including four putative class action lawsuits, which seek unspecified monetary damages, credit
monitoring and other relief.
In
connection with this matter, DSW entered into a consent order with
the Federal Trade Commission (FTC), which has jurisdiction over consumer protection matters. The FTC published the final order
on March 14, 2006, and copies of the complaint and consent order are available from the FTCs Web
site at http://www.ftc.gov and also from the FTCs Consumer Response Center, Room 130, 600
Pennsylvania Avenue, N.W., Washington, D.C. 20580. DSW has not admitted any wrongdoing or that the
facts alleged in the FTCs proposed unfairness complaint are true. Under the consent order, DSW
will pay no fine or damages. DSW has agreed, however, to maintain a comprehensive information
security program and to undergo a biannual assessment of such program by an independent third
party.
There can be no assurance that there will not be additional proceedings or claims brought against
DSW in the future. We have contested and will continue to vigorously contest the claims made
against us and will continue to explore our defenses and possible claims against others.
We estimate that the potential exposure for losses related to this theft, including exposure under
currently pending proceedings, ranges from approximately $6.5 million to approximately $9.5
million. Because of many factors, including the early development of information regarding the
theft and recoverability under insurance policies, there is no amount in the estimated range that
represents a better estimate than any other amount in the range. Therefore, in accordance with
Financial Accounting Standard No. 5, Accounting for Contingencies, we accrued a charge to
operations in the first quarter of fiscal 2005 equal to the low end of the range set forth above.
As the situation develops and more information becomes available, the amount of the reserve may
increase or decrease accordingly. The amount of any such change may be material.
Although difficult to quantify, since the announcement of the theft, we have not discerned any
material negative effect on sales trends we believe is attributable to the theft. However, this may
not be indicative of the long-term developments regarding this matter.
We are involved in various other legal proceedings that are incidental to the conduct of our
business. We estimate the range of liability related to pending litigation where the amount of the
range of loss can be estimated. We recorded our best estimate of a loss when the loss is considered
probable. Where a liability is probable and there is a range of estimated loss, we recorded the
most likely estimated liability related to the claim. In the opinion of management, the amount of
any liability with respect to these proceedings will not be material. As additional
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information becomes available, we will assess the potential liability related to our pending
litigation and revise the estimates. Revisions in our estimates and potential liability could
materially impact our results of operations and financial condition.
ITEM 1A. Risk Factors.
We caution that information in this Form 10-Q, particularly information regarding future
economic performance and finances, and plans, expectations and objectives of management, is
forward-looking (as such term is defined in the Private Securities Litigation Reform Act of 1995)
and is subject to change based on various important factors. The following factors, in addition to
factors previously disclosed under the caption Risk Factors in our last Annual Report on Form
10-K for the fiscal year-ended January 28, 2006, and other possible factors not listed, could
affect our actual results and cause such results to differ materially from those expressed in
forward-looking statements.
In the
event that Retail Ventures completes the offering of the Mandatorily
Exchangeable Notes, which Retail Ventures refers to as
PIES, described in the Registration Statement filed by it
on May 17, 2006, the offering of PIES may adversely affect the
market price for DSW Class A Common Shares.
In the
event that Retail Ventures completes the offering of the PIES
described in the Registration Statement filed by Retail Ventures on
May 17, 2006, the offering of the PIES may adversely affect the
market price for DSW Class A Common Shares.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) Recent sales of unregistered securities. Not applicable.
(b) Use of Proceeds. Not applicable.
(c) Purchases of equity securities by the issuer and affiliated purchasers
DSW made no purchases of its Common Shares during the quarter
ended April 29, 2006.
We do not anticipate paying cash dividends on our Common Shares in
the foreseeable future.
Presently, we expect that all of our future earnings will be retained for development of our
business. The payment of any future dividends will be at the discretion of our board of directors
and will depend upon, among other things, future earnings, operations, capital requirements, our
general financial condition and general business conditions. Our credit facility restricts the
payment of dividends by us or our subsidiaries, other than dividends
paid in stock, and cash dividends can only be paid to Retail Ventures by us up to the aggregate amount
of $5.0 million, less the amount of any loan advances made to Retail Ventures by us or our
subsidiaries.
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Item 3. Defaults Upon Senior Securities. None.
Item 4. Submission of Matters to a Vote of Security Holders. None.
Item 5. Other Information. None.
Item 6. Exhibits. See Index to Exhibits on page 33.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
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DSW INC.
(Registrant)
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Date: June 8, 2006 |
By: |
/s/ Douglas J. Probst
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Douglas J. Probst |
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Chief Financial Officer |
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INDEX TO EXHIBITS
|
|
|
Exhibit Number |
|
Description |
|
|
|
31.1
|
|
Rule 13a-14(a)/15d-14(a)
Certification of Chief Executive Officer |
|
|
|
31.2
|
|
Rule 13a-14(a)/15d-14(a)
Certification of Chief Financial Officer |
|
|
|
32.1
|
|
Section 1350 Certification of
Chief Executive Officer |
|
|
|
32.2
|
|
Section 1350 Certification of
Chief Financial Officer |
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