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 November 3, 2007
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 |
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(State or other jurisdiction of
Incorporation or organization)
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(I.R.S. Employer Identification No.) |
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810 DSW Drive, Columbus, Ohio
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43219 |
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(Address of principal executive offices)
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(Zip Code) |
(614) 237-7100
Registrants telephone number, including area code
N/A
(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 þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes þ No
The number of outstanding Class A Common Shares, without par value, as of November 30, 2007 was
16,255,798 and Class B Common Shares, without par value, as of November 30, 2007 was
27,702,667.
DSW INC.
TABLE OF CONTENTS
-1-
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
DSW INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(unaudited)
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November 3, |
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February 3, |
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2007 |
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2007 |
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ASSETS |
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Cash and equivalents |
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$ |
46,410 |
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$ |
73,205 |
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Short-term investments |
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94,700 |
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98,650 |
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Accounts receivable, net |
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9,697 |
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4,661 |
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Accounts receivable from related parties |
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3,114 |
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3,623 |
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Inventories |
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274,927 |
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237,737 |
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Prepaid expenses and other assets |
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25,404 |
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22,049 |
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Deferred income taxes |
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19,777 |
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18,046 |
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Total current assets |
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474,029 |
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457,971 |
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Property and equipment, net |
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169,569 |
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116,872 |
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Long-term investments |
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2,500 |
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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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4,736 |
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5,355 |
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Other assets |
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4,001 |
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2,206 |
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Total assets |
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$ |
680,734 |
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$ |
608,303 |
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LIABILITIES AND SHAREHOLDERS EQUITY |
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Accounts payable |
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$ |
109,188 |
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$ |
89,806 |
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Accounts payable to related parties |
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661 |
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5,161 |
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Accrued expenses: |
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Compensation |
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5,519 |
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17,288 |
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Taxes |
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11,101 |
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10,935 |
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Gift cards and merchandise credits |
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10,832 |
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11,404 |
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Other |
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25,846 |
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24,673 |
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Total current liabilities |
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163,147 |
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159,267 |
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Deferred income taxes and other non-current liabilities |
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86,887 |
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74,457 |
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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; 16,255,798 and 16,238,765
issued and outstanding, respectively |
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286,663 |
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283,108 |
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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
Retained earnings |
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144,037 |
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91,471 |
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Total shareholders equity |
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430,700 |
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374,579 |
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Total liabilities and shareholders equity |
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$ |
680,734 |
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$ |
608,303 |
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The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements.
-2-
DSW INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
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Three months ended |
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Nine months ended |
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November 3, |
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October 28, |
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November 3, |
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October 28, |
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2007 |
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2006 |
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2007 |
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2006 |
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Net sales |
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$ |
367,380 |
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$ |
332,219 |
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$ |
1,073,095 |
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$ |
950,008 |
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Cost of sales |
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(260,720 |
) |
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(233,544 |
) |
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(775,829 |
) |
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(672,944 |
) |
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Gross profit |
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106,660 |
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98,675 |
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297,266 |
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277,064 |
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Operating expenses |
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(71,855 |
) |
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(73,451 |
) |
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(216,917 |
) |
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(200,854 |
) |
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Operating profit |
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34,805 |
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25,224 |
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80,349 |
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76,210 |
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Interest expense |
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(140 |
) |
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(145 |
) |
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(421 |
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(428 |
) |
Interest income |
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1,673 |
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1,708 |
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5,621 |
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5,290 |
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Interest income, net |
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1,533 |
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1,563 |
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5,200 |
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4,862 |
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Earnings before income taxes |
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36,338 |
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26,787 |
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85,549 |
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81,072 |
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Income tax provision |
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(13,906 |
) |
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(10,786 |
) |
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(32,852 |
) |
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(32,211 |
) |
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Net income |
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$ |
22,432 |
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$ |
16,001 |
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$ |
52,697 |
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$ |
48,861 |
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Basic and diluted earnings per share: |
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Basic |
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$ |
0.51 |
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$ |
0.36 |
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$ |
1.20 |
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$ |
1.11 |
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Diluted |
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$ |
0.51 |
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$ |
0.36 |
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$ |
1.19 |
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$ |
1.11 |
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Shares used in per share calculations: |
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Basic |
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43,957 |
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43,922 |
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43,951 |
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43,909 |
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Diluted |
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44,274 |
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44,226 |
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44,324 |
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44,193 |
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The accompanying Notes are an integral part of the Condensed Consolidated Financial
Statements.
-3-
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 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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48,861 |
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48,861 |
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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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10 |
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|
291 |
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|
291 |
|
Exercise of stock options |
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22 |
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|
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|
416 |
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|
|
|
|
|
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|
416 |
|
Excess tax benefit related to stock
options exercised |
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|
|
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|
93 |
|
|
|
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|
|
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|
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|
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|
93 |
|
Stock based compensation expense,
before related tax effects |
|
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|
|
|
|
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|
2,661 |
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2,661 |
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Balance, October 28, 2006 |
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16,222 |
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|
27,703 |
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$ |
282,170 |
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$ |
0 |
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|
$ |
74,868 |
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|
$ |
0 |
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|
$ |
357,038 |
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|
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Balance, February 3, 2007 |
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|
16,239 |
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|
|
27,703 |
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|
$ |
283,108 |
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$ |
0 |
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$ |
91,471 |
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|
$ |
0 |
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|
$ |
374,579 |
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|
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|
|
|
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|
|
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Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
52,697 |
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|
|
|
|
|
|
52,697 |
|
Cumulative effect of FIN 48 adoption |
|
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|
|
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|
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|
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|
(131 |
) |
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(131 |
) |
Stock units granted |
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|
9 |
|
|
|
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|
|
|
325 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
325 |
|
Exercise of stock options |
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8 |
|
|
|
|
|
|
|
64 |
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
64 |
|
Excess tax benefit related to stock
options exercised |
|
|
|
|
|
|
|
|
|
|
63 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
63 |
|
Stock based compensation expense,
before related tax effects |
|
|
|
|
|
|
|
|
|
|
3,103 |
|
|
|
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|
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|
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|
|
3,103 |
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Balance, November 3, 2007 |
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|
16,256 |
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|
|
27,703 |
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|
$ |
286,663 |
|
|
$ |
0 |
|
|
$ |
144,037 |
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|
$ |
0 |
|
|
$ |
430,700 |
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|
The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements.
-4-
DSW INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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|
|
|
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Nine months ended |
|
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|
November 3, |
|
October 28, |
|
|
2007 |
|
2006 |
|
Cash flows from operating activities: |
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|
|
|
|
|
|
|
Net income |
|
$ |
52,697 |
|
|
$ |
48,861 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
17,151 |
|
|
|
14,201 |
|
Amortization of debt issuance costs |
|
|
88 |
|
|
|
88 |
|
Stock based compensation expense |
|
|
3,103 |
|
|
|
2,661 |
|
Deferred income taxes |
|
|
572 |
|
|
|
(2,077 |
) |
Loss on disposal of assets |
|
|
115 |
|
|
|
529 |
|
Impairment of fixed assets |
|
|
720 |
|
|
|
817 |
|
Grants of stock units |
|
|
325 |
|
|
|
291 |
|
Other |
|
|
(260 |
) |
|
|
4,519 |
|
Change in working capital, assets and liabilities: |
|
|
|
|
|
|
|
|
Accounts receivable, net |
|
|
(5,036 |
) |
|
|
304 |
|
Accounts receivable from related parties |
|
|
509 |
|
|
|
(5,780 |
) |
Inventories |
|
|
(37,190 |
) |
|
|
(18,349 |
) |
Prepaid expenses and other assets |
|
|
(5,238 |
) |
|
|
(1,785 |
) |
Accounts payable |
|
|
12,089 |
|
|
|
7,982 |
|
Accrued expenses |
|
|
(10,980 |
) |
|
|
10,677 |
|
Proceeds from tenant and construction allowances |
|
|
10,256 |
|
|
|
4,315 |
|
|
Net cash provided by operating activities |
|
|
38,921 |
|
|
|
67,254 |
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Cash paid for property and equipment |
|
|
(67,272 |
) |
|
|
(19,981 |
) |
Purchases of available-for-sale investments |
|
|
(87,100 |
) |
|
|
(150,400 |
) |
Maturities and sales from available-for-sale investments |
|
|
88,550 |
|
|
|
75,050 |
|
Purchase of intangible asset |
|
|
(21 |
) |
|
|
|
|
|
Net cash used in investing activities |
|
|
(65,843 |
) |
|
|
(95,331 |
) |
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Proceeds from exercise of stock options |
|
|
64 |
|
|
|
416 |
|
Excess tax benefit related to stock option exercises |
|
|
63 |
|
|
|
93 |
|
|
Net cash provided by financing activities |
|
|
127 |
|
|
|
509 |
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and equivalents |
|
|
(26,795 |
) |
|
|
(27,568 |
) |
Cash and equivalents, beginning of period |
|
|
73,205 |
|
|
|
124,759 |
|
|
Cash and equivalents, end of period |
|
$ |
46,410 |
|
|
$ |
97,191 |
|
|
The accompanying Notes are an integral part of the Condensed Consolidated Financial
Statements
-5-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BUSINESS OPERATIONS
DSW Inc. (DSW) and its wholly-owned subsidiaries, including DSW Shoe Warehouse, Inc.
(DSWSW) and Brand Technology Services LLC (BTS), are herein referred to collectively as
DSW or the Company. DSWs Class A Common Shares are listed on the New York Stock Exchange
under the ticker symbol DSW. At November 3, 2007, Retail Ventures, Inc. (RVI or Retail
Ventures) owned approximately 63.0% of DSWs outstanding Common Shares, representing
approximately 93.2% of the combined voting power of DSWs outstanding Common Shares.
DSW operates in two segments, DSW stores and leased departments, and sells better-branded
footwear in both. As of November 3, 2007, DSW operated a total of 250 stores located
throughout the United States. DSW stores offer a wide selection of brand name and designer
dress, casual and athletic footwear for men and women, as well as accessories. During the nine
months ended November 3, 2007, DSW opened 28 new DSW stores and closed one store. DSW also
operates leased departments for three non-affiliated retailers and one affiliated retailer in
its leased department segment. During the nine months ended November 3, 2007, DSW added 11
new non-affiliated leased departments, seven affiliated leased departments and ceased
operations in two non-affiliated leased departments and one affiliated leased department. DSW
owns the merchandise, records sales of merchandise net of returns and sales tax, owns the
fixtures (except for Filenes Basement, the affiliated retailer) and provides supervisory
assistance in these locations. Stein Mart, Inc. (Stein Mart), Gordmans, Inc. (Gordmans),
and Filenes Basement stores Frugal Fannies Fashion Warehouse (Frugal Fannies), provide
the sales associates. DSW pays a percentage of net sales as rent. As of November 3, 2007, DSW
supplied merchandise to 275 Stein Mart stores, 63 Gordmans stores, 36 Filenes Basement
stores, and one Frugal Fannies store.
2. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated 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 5, 2007 (the 2006 Annual Report).
In the opinion of management, the unaudited interim condensed consolidated financial
statements reflect all adjustments, consisting of normal recurring adjustments, which are
necessary to present fairly the consolidated financial position, results of operations and
cash flows for the periods presented.
3. ADOPTION OF ACCOUNTING STANDARDS
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.
48, Accounting for Uncertainty in Income Taxes, (FIN 48) and in May 2007, the FASB issued
FASB Staff Position FIN 48-1 Definition of Settlement in FASB Interpretation No. 48. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an enterprises
financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes.
The evaluation of a tax position in accordance with FIN 48 is a two step process. The first
step is recognition: the enterprise determines whether it is more likely than not that a tax
position will be sustained upon examination, including resolution of any related appeals or
litigation processes, based on the technical merits of the position. The second step is
measurement: a tax position that meets the more likely than not recognition threshold is
measured to determine that amount of benefit to recognize in the financial statements. The tax
position is measured at the largest amount of benefit that is greater than 50 percent likely
of being realized upon ultimate settlement. FIN 48 provides for a cumulative effect of a
change in accounting principle to be recorded as an adjustment to the opening balance of
retained earnings upon the initial adoption. DSW adopted FIN 48 effective February 4, 2007.
The impact of this adoption is presented in Note 8.
In
September 2006, the FASB issued FASB Statement No. 157,
Fair Value Measurements, (FAS 157) which
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. This statement is effective for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. The FASB has
provided a one-year deferral for the implementation of FAS 157
for non-financial assets and liabilities that are not required or
permitted to be measured at fair value on a recurring basis. DSW is currently evaluating the impact
this statement may have on its consolidated financial statements.
In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (FAS 159). This statement allows entities to choose to
measure financial instruments and certain other
-6-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
financial assets and financial liabilities at fair value. FAS 159 is effective for fiscal
years beginning after November 15, 2007. DSW is currently evaluating the impact this
statement may have on its consolidated financial statements.
4. STOCK BASED COMPENSATION
DSW 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, restricted stock units, and
director stock units to management, key employees of DSW and affiliates, consultants (as
defined in the plan), and non-employee directors of DSW.
During each of the three months ended November 3, 2007 and October 28, 2006, the Company
recorded stock based compensation expense of approximately $1.1 million and for the nine
months ended November 3, 2007 and October 28, 2006, the Company recorded stock based
compensation expense of approximately $3.1 million and $2.7 million, respectively.
Stock Options
The following table illustrates the weighted-average assumptions used in the Black-Scholes
option-pricing model for options granted in each of the periods presented.
|
|
|
|
|
|
|
|
|
|
|
Nine months ended |
|
|
November 3, |
|
October 28, |
|
|
2007 |
|
2006 |
|
|
|
|
|
|
|
|
|
|
|
|
Assumptions: |
|
|
|
|
|
|
|
|
Risk-free interest rate |
|
|
4.5 |
% |
|
|
4.6 |
% |
Expected volatility of DSW common stock |
|
|
39.4 |
% |
|
|
40.5 |
% |
Expected option term |
|
5 years |
|
5 years |
Expected dividend yield |
|
|
0.0 |
% |
|
|
0.0 |
% |
The weighted-average grant date fair value of each option granted in the three months ended
November 3, 2007 and October 28, 2006 was $11.54 and $11.76 per share, respectively, and for
the nine months ended November 3, 2007 and October 28, 2006 was $17.38 and $12.93 per share,
respectively.
The following table summarizes the Companys stock option activity for the nine months ended
November 3, 2007:
|
|
|
|
|
|
|
Nine months ended |
|
|
November 3, 2007 |
|
|
(in thousands) |
Outstanding beginning of period |
|
|
1,084 |
|
Granted |
|
|
520 |
|
Exercised |
|
|
(13 |
) |
Forfeited |
|
|
(71 |
) |
|
|
|
|
|
Outstanding end of period |
|
|
1,520 |
|
|
|
|
|
|
Exercisable end of period |
|
|
331 |
|
-7-
DSW Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Restricted Stock Units
The following table summarizes DSWs restricted stock unit activity for the nine months ended
November 3, 2007:
|
|
|
|
|
|
|
Nine months ended |
|
|
November 3, 2007 |
|
|
(in thousands) |
Outstanding beginning of period |
|
|
135 |
|
Granted |
|
|
23 |
|
Vested |
|
|
|
|
Forfeited |
|
|
(3 |
) |
|
|
|
|
|
Outstanding end of period |
|
|
155 |
|
|
|
|
|
|
The total aggregate intrinsic value of nonvested restricted stock units at November 3, 2007
was $3.3 million. As of November 3, 2007, the total compensation cost related to nonvested
restricted stock units not yet recognized was approximately $3.7 million with a weighted
average expense recognition period remaining of 1.9 years. The weighted average exercise
price for all restricted stock units is zero.
Director Stock Units
DSW issues stock units to directors who are not employees of DSW or RVI. During the nine
months ended November 3, 2007, DSW granted 9,294 director stock units and expensed
approximately $0.3 million related to these grants. As of November 3, 2007, 36,832 director
stock units had been issued and no director stock units had been settled.
5. INVESTMENTS
Short-term and long-term investments include auction rate securities and are classified as
available-for-sale securities. These securities are recorded at cost, which approximates fair
value due to their variable interest rates, which typically reset every 7 to 189 days. Despite
the long-term nature of their stated contractual maturities, the Company has the intent and
ability to quickly liquidate these securities. As a result of the resetting variable rates,
there are no cumulative gross unrealized or realized holding gains or losses from these
investments. All income generated from these investments is recorded as interest income.
During the nine months ended November 3, 2007, $87.1 million of cash was used to purchase
available-for-sale securities while $88.6 million was generated by the sale of
available-for-sale securities. The table below details the investments classified as
available-for-sale at November 3, 2007 and February 3, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 3, 2007 |
|
|
February 3, 2007 |
|
|
|
Maturity of |
|
|
Maturity of |
|
|
|
Less than 1 |
|
|
1 to 3 |
|
|
Less than |
|
|
1 to 3 |
|
|
|
year |
|
|
years |
|
|
1 year |
|
|
years |
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Aggregate fair value |
|
$ |
94,700 |
|
|
$ |
2,500 |
|
|
$ |
98,650 |
|
|
$ |
|
|
Gross unrecognized holding gains |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross unrecognized holding losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount |
|
$ |
94,700 |
|
|
$ |
2,500 |
|
|
$ |
98,650 |
|
|
$ |
|
|
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 director 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.
-8-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Nine months ended |
|
|
|
November 3, |
|
|
October 28, |
|
|
November 3, |
|
|
October 28, |
|
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Weighted average shares outstanding |
|
|
43,957 |
|
|
|
43,922 |
|
|
|
43,951 |
|
|
|
43,909 |
|
Assumed exercise of dilutive restricted stock units |
|
|
152 |
|
|
|
144 |
|
|
|
146 |
|
|
|
136 |
|
Assumed exercise of dilutive stock options |
|
|
165 |
|
|
|
160 |
|
|
|
227 |
|
|
|
148 |
|
|
|
|
Number of shares for computation of dilutive
earnings per share |
|
|
44,274 |
|
|
|
44,226 |
|
|
|
44,324 |
|
|
|
44,193 |
|
Options to purchase 0.7 million and 0.1 million shares of common stock were outstanding at
November 3, 2007 and October 28, 2006, respectively, but were not included in the computation
of diluted earnings per share because the options exercise prices were greater than the
average market price of the common shares for the period and, therefore, the effect would not
be dilutive.
7. LONG-TERM OBLIGATIONS
DSW $150 Million Credit Facility At November 3, 2007 and February 3, 2007, DSW had no
borrowings outstanding under its $150 million secured revolving credit facility and was in
compliance with the terms of the credit facility. DSWs obligations under its secured
revolving credit facility are collateralized by a lien on substantially all of DSWs and
DSWSWs personal property and a pledge of all of its shares of DSWSW. In addition, the
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, 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 the
facility, it must comply with a fixed charge coverage ratio test set forth in the facility
documents. At November 3, 2007 and February 3, 2007, $137.0 million and $136.6 million were
available under the facility and no direct borrowings were outstanding. At November 3, 2007
and February 3, 2007, $13.0 million and $13.4 million in letters of credit were issued and
outstanding, respectively.
Deferred Rent Many of the Companys operating leases contain predetermined fixed increases
of the minimum rental rate during the initial lease term. For these leases, the Company
recognizes the related rental expense on a straight-line basis and records the difference
between the amount charged to expense and the rent paid as deferred rent and begins amortizing
such deferred rent upon the delivery of the lease location by the lessor. The amounts included
in the other noncurrent liabilities caption was $28.5 million and $26.0 million at November 3,
2007 and February 3, 2007, respectively.
Tenant and Construction Allowances The Company receives cash allowances from landlords,
which are deferred and amortized on a straight-line basis over the life of the lease as a
reduction of rent expense. These allowances were $55.6 million and $48.4 million at November
3, 2007 and February 3, 2007, respectively.
8. INCOME TAXES
Effective February 4, 2007, the Company adopted the provisions of FIN 48. The adoption of FIN
48 resulted in a charge of $0.1 million to beginning retained earnings.
As of February 4, 2007, the total amount of unrecognized tax benefits was $2.0 million.
Unrecognized tax benefits of $2.0 million would affect the Companys effective tax rate if
recognized. There were no significant changes in components of the unrecognized tax benefits
for the nine months ended November 3, 2007.
The Company is no longer subject to U.S federal income tax examination for years prior to
2004. With a few exceptions, the Company is no longer subject to state tax examination for
fiscal years prior to 2002. The Company estimates the range of possible changes that may
result from the examinations to be insignificant at this time.
DSW has amended certain federal and state tax returns which reversed a tax benefit of $1.1
million related to the deduction of deferred state taxes. This amount was reserved for in
fiscal 2006.
-9-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Consistent with its historical financial reporting, the Company has elected to classify
interest expense related to income tax liabilities, when applicable, as part of the interest
expense in its condensed consolidated statement of income rather than income tax expense. The
Company will continue to classify income tax penalties as part of operating expenses in its
condensed consolidated statements of income. As of November 3, 2007 and February 4, 2007, $0.3
million was accrued for the payment of interest and penalties.
9. SEGMENT REPORTING
The Company is managed in two operating segments: DSW 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Leased |
|
|
|
|
DSW Stores |
|
Departments |
|
Total |
|
|
|
|
|
(in thousands) |
Three months ended November 3,
2007: |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
321,471 |
|
|
$ |
45,909 |
|
|
$ |
367,380 |
|
Gross profit |
|
|
97,723 |
|
|
|
8,937 |
|
|
|
106,660 |
|
Capital expenditures |
|
|
30,368 |
|
|
|
485 |
|
|
|
30,853 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of November 3, 2007: |
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
630,989 |
|
|
$ |
49,745 |
|
|
$ |
680,734 |
|
|
Three months ended October 28, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
298,618 |
|
|
$ |
33,601 |
|
|
$ |
332,219 |
|
Gross profit |
|
|
92,708 |
|
|
|
5,967 |
|
|
|
98,675 |
|
Capital expenditures |
|
|
9,117 |
|
|
|
192 |
|
|
|
9,309 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of February 3, 2007: |
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
562,515 |
|
|
$ |
45,788 |
|
|
$ |
608,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Leased |
|
|
|
|
DSW Stores |
|
Departments |
|
Total |
|
|
|
|
|
(in thousands) |
Nine months ended November 3,
2007: |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
937,594 |
|
|
$ |
135,501 |
|
|
$ |
1,073,095 |
|
Gross profit |
|
|
276,463 |
|
|
|
20,803 |
|
|
|
297,266 |
|
Capital expenditures |
|
|
68,977 |
|
|
|
1,097 |
|
|
|
70,074 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended October
28, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
852,809 |
|
|
$ |
97,199 |
|
|
$ |
950,008 |
|
Gross profit |
|
|
260,067 |
|
|
|
16,997 |
|
|
|
277,064 |
|
Capital expenditures |
|
|
21,434 |
|
|
|
364 |
|
|
|
21,798 |
|
-10-
DSW INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
|
|
Nine months ended |
|
|
November 3, |
|
October 28, |
|
|
2007 |
|
2006 |
|
|
|
|
|
(in thousands) |
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
|
|
|
$ |
7 |
|
Income taxes |
|
$ |
44,352 |
|
|
$ |
28,336 |
|
|
|
|
|
|
|
|
|
|
Noncash investing and operating activities |
|
|
|
|
|
|
|
|
Increase in accounts payable due to asset purchases |
|
$ |
2,793 |
|
|
$ |
1,702 |
|
11. COMMITMENTS AND CONTINGENCIES
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 the Companys 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.
The Company and Retail Ventures contacted and continue to cooperate with law enforcement and
other authorities with regard to this matter. The Company is involved in a putative class
action lawsuit which seeks unspecified monetary damages, credit monitoring and other relief.
The lawsuit seeks to certify a class of consumers that is limited geographically to consumers
who made purchases at certain stores in Ohio.
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 estimated 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 possible settlement of
claims 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 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 to the Companys results of operations or financial condition. As
of November 3, 2007, the balance of the associated accrual for potential exposure was $0.5
million.
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 of the 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 most likely estimated liability related to
the claim. In the opinion of management, the amount of any potential liability with respect to
these proceedings will not be material to the Companys results of operations or financial
condition. As additional information becomes available, the Company will assess the potential
liability related to its pending litigation and revise the estimates as needed. Revisions in
its estimates and potential liability could materially impact the Companys results of
operations and financial condition.
-11-
Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations.
All references to we, us, our, DSW or the Company in this Quarterly Report on Form
10-Q mean DSW Inc. and its wholly-owned subsidiaries, including DSW Shoe Warehouse, Inc.
(DSWSW) and Brand Technology Services LLC (BTS), except where it is made clear that the
term only means DSW Inc. DSW Class A Common Shares are listed under the ticker symbol DSW
on the New York Stock Exchange (NYSE).
All
references to Retail Ventures, or RVI in this Quarterly Report on Form 10-Q mean
Retail Ventures, Inc. and its subsidiaries, except where it is made clear that the term only
means the parent company. DSW is a controlled subsidiary of Retail Ventures. RVI Common
Shares are listed under the ticker symbol RVI on the NYSE.
Company Overview
DSW is a leading U.S. specialty branded footwear retailer operating 250 shoe stores in 36
states as of November 3, 2007. We offer a wide selection of brand name and designer dress,
casual and athletic footwear for women and men. Our typical customers are brand-, quality-
and style-conscious shoppers who have a passion for footwear and accessories. Our core focus
is to create a distinctive store experience that satisfies both the rational and emotional
shopping needs of our customers by offering them a vast, exciting selection of in-season
styles combined with the convenience and value they desire. Our stores average approximately
25,000 square feet and hold approximately 30,000 pairs of shoes. We believe this
combination of selection, convenience and value differentiates us from our competitors and
appeals to consumers from a broad range of socioeconomic and demographic backgrounds. In
addition, we also operate leased departments for four other retailers.
Cautionary Statement Regarding Forward-Looking Information for Purposes of the Safe Harbor
Provisions of the Private Securities Litigation Reform Act of 1995
Some of the statements in this Quarterly Report on Form 10-Q contain forward-looking
statements 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, 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 and
assumptions relating to our operations, results of operations, financial condition, growth
strategy and liquidity. 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 numerous risks, uncertainties and other factors that may cause actual results,
performance or achievements to be materially different from any future results, performance
or achievements expressed or implied by the forward-looking statements. In addition to
those described under Part I, Item 1A. Risk Factors, of our Form 10-K filed on April 5,
2007, and Part II, Item 1A. Risk Factors in this Form
10-Q, some important factors that could cause actual results, performance or achievements
for DSW to differ materially from those discussed in forward looking statements include, but
are not limited to, the following:
|
|
our success in opening and operating new stores on a timely and profitable basis; |
|
|
|
maintaining good relationships with our vendors; |
|
|
|
our ability to anticipate and respond to fashion trends; |
|
|
|
fluctuation of our comparable store sales and quarterly financial performance; |
|
|
|
disruption of our distribution operations; |
|
|
|
our dependence on Retail Ventures for key services; |
|
|
|
the impact of a Value City strategic transaction or
discontinuance of operations could have on the allocation of expenses
pursuant to the shared services agreement with RVI; |
|
|
|
failure to retain our key executives or attract qualified new personnel; |
|
|
|
our competitiveness with respect to style, price, brand availability and customer
service; |
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declining general economic conditions; |
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risks inherent to international trade with countries that are major manufacturers of
footwear; and |
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security risks related to our electronic processing and transmission of confidential
customer information. |
If one or more of these or other risks or uncertainties materialize, or if our underlying
assumptions prove to be incorrect, actual results, performance or achievements may vary
materially from what we may have projected. Furthermore, new factors emerge from time to
time and it is not possible for management to predict all such factors, nor can it assess
the impact of any such factor on the business or the extent to which any factor, or
combination of factors, may cause results to differ materially from those contained in any
forward-looking statement. Any forward-looking statement speaks only as of the date on which
such statement is made. DSW undertakes no obligation to update any forward-looking statement
to
-12-
reflect events or circumstances after the date on which such statement is made or to reflect
the occurrence of unanticipated events.
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 general liability insurance, 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
financial 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 sales tax. Revenue from gift cards is deferred and the
revenue is recognized upon redemption of the gift cards. The Company did not recognize
income during these periods from unredeemed gift cards and merchandise credits. The
Company will continue to review its historical activity and will recognize income from
unredeemed gift cards and merchandise credits when deemed appropriate. |
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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 $22.2 million
at November 3, 2007 and $21.2 million at February 3, 2007. |
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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 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 |
-13-
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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, based
on discounted cash flow. Any impairment loss realized is included in cost of sales. There
were $0.7 million in impairment losses recorded during the three and nine months ended
November 3, 2007. We recorded zero and $0.8 million in impairment losses during the three
and nine months ended October 28, 2006. We believe at this time that the long-lived
assets carrying amounts and useful lives continue to be appropriate. To the extent these
future projections or our strategies change, the conclusion regarding 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 general liability 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 general liability insurance exceed those anticipated,
reserves recorded may not be sufficient, and, to the extent actual results vary from
assumptions, earnings would be impacted. For example, for workers compensation and
liability claims estimates, a 1% increase or decrease to the assumptions for claims
costs and loss development factors would increase or decrease our self-insurance
accrual by less than $0.1 million. The self-insurance reserves were $1.9 million and
$1.7 million at November 3, 2007 and February 3, 2007, respectively. |
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Customer Loyalty Program. We maintain a customer loyalty program for our DSW stores
in which program members receive a discount on future purchases. Upon reaching the
target-earned threshold, our members receive certificates for these discounts which
must be redeemed within six months. We accrue the anticipated redemptions of the
discount earned at the time of the initial purchase. To estimate these costs, we are
required to make assumptions related to customer purchase levels and redemption rates
based on historical experience. The accrued liability as of November 3, 2007 and
February 3, 2007 was $5.8 million and $5.0 million, respectively. |
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Investments. Short-term and long-term investments include auction rate securities
and are classified as available-for-sale securities. These securities are recorded at
cost, which approximates fair value due to their variable interest rates, which
typically reset every 7 to 189 days. Despite the long-term nature of their stated
contractual maturities, we have the intent and ability to quickly liquidate these
securities. As a result of the resetting variable rates, there are no cumulative gross
unrealized or realized holding gains or losses from these investments. All income
generated from these investments is recorded as interest income. As of November 3,
2007, we held $94.7 million in short-term investments and $2.5 million in long-term
investments and at February 3, 2007, we held $98.7 million in short-term investments
and no long-term investments. |
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Store Closing Reserves. During the nine months ended November 3, 2007, we recorded
$0.3 million in expenses associated with the closing of one DSW store. During the nine
months ended October 28, 2006, we recorded $0.5 million in expenses associated with the
closing of four DSW stores. The operating lease at one of the four stores was
terminated through the exercise of a lease kick-out option. Expenses related to closed
stores are recorded as operating expenses. These reserves are monitored on at least a
quarterly basis for changes in circumstances. The accrued store closing reserves were
$0.1 million at both November 3, 2007 and February 3, 2007. |
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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 realized. If our management had made these
determinations on a different basis, our tax expense, assets and liabilities could be
different. |
-14-
Results of Operations
We manage our operations in two segments, defined as DSW stores and leased departments. As
of November 3, 2007, we operated 250 DSW stores in 36 states, and leased departments in 275
Stein Mart stores, 63 Gordmans stores, 36 Filenes Basement stores and one Frugal Fannies
store. 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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Nine months ended |
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November 3, |
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October 28, |
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November 3, |
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October 28, |
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2007 |
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2006 |
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2007 |
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2006 |
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Net sales |
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100.0 |
% |
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100.0 |
% |
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100.0 |
% |
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100.0 |
% |
Cost of sales |
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(71.0 |
) |
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(70.3 |
) |
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(72.3 |
) |
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(70.8 |
) |
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Gross profit |
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29.0 |
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29.7 |
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27.7 |
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29.2 |
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Operating expenses |
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(19.5 |
) |
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(22.1 |
) |
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(20.2 |
) |
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(21.2 |
) |
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Operating profit |
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9.5 |
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7.6 |
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7.5 |
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8.0 |
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Interest income, net |
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0.4 |
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0.5 |
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0.5 |
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0.5 |
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Earnings before
income taxes |
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9.9 |
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8.1 |
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8.0 |
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8.5 |
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Income tax provision |
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(3.8 |
) |
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(3.3 |
) |
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(3.1 |
) |
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(3.4 |
) |
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Net income |
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6.1 |
% |
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4.8 |
% |
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4.9 |
% |
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5.1 |
% |
THREE MONTHS ENDED NOVEMBER 3, 2007 COMPARED TO THREE MONTHS ENDED OCTOBER 28, 2006
Net Sales. Sales for the three months ended November 3, 2007 increased by 10.6%, or $35.2
million, to $367.4 million from $332.2 million for the three months ended October 28, 2006.
The increase in DSW sales includes a net increase of 35 DSW stores, 114 non-affiliated
leased departments and seven affiliated leased departments. The DSW store locations and
leased departments opened subsequent to October 28, 2006 added $28.2 million and $11.7
million, respectively, in sales for the quarter ended November 3, 2007. Leased department
sales comprised 12.5% of total net sales in the third quarter of fiscal 2007, compared to
10.1% in the third quarter of fiscal 2006. The increase in sales was partially offset by the
loss of sales from the closed stores and closed leased departments of $3.4 million.
Our comparable store sales for the third quarter of fiscal 2007 decreased 3.0%, or $9.4
million, compared to the third quarter of fiscal 2006 due principally to a decline in customer traffic.
For the third quarter of fiscal 2007, DSW comparable store sales decreased in womens and
mens by 5.0% and 5.3%, respectively, and increased in accessories and athletic by 10.7% and
2.2%, respectively.
Gross Profit. Gross profit increased $8.0 million to $106.7 million in the third quarter of
fiscal 2007 from $98.7 million in the third quarter of fiscal 2006, and decreased as a
percentage of net sales to 29.0% in the third quarter of fiscal 2007 from 29.7% in the third
quarter of fiscal 2006. By operating segment, gross profit as a percentage of sales was:
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November 3, 2007 |
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October 28, 2006 |
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DSW Stores |
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30.4 |
% |
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31.0 |
% |
Leased Departments |
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19.5 |
% |
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17.8 |
% |
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29.0 |
% |
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29.7 |
% |
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The gross profit margin for the third quarter of fiscal 2007 was negatively impacted by an
increase in store occupancy expense, an increase in markdowns, which was partially offset by
an increase in initial mark-up. Store occupancy expense increased to 13.9% of net sales in
the third quarter of fiscal 2007 from 13.0% of net sales in the third quarter of fiscal 2006
as a result of an impairment charge of $0.7 million and additional Stein Mart stores added
since January 2007.
Operating Expenses. For the third quarter of fiscal 2007, operating expenses decreased $1.5
million to $71.9 million from $73.4 million in the third quarter of fiscal 2006, which
represented 19.5% and 22.1% of net sales, respectively. The decrease in operating expenses
as a percent of sales was primarily due to the decrease in bonus
expense of $8.3 million primarily due
to the reversal of the current year to date bonus accrual and a decrease in marketing
expenses as compared to third quarter 2006 due to the nonrecurring expenses related to the
change in the loyalty program. These decreases were partially offset by increases in home
office personnel related expenses, $1.7 million of expenses related to the start-up of our
e-commerce channel and depreciation expense. The DSW stores and leased departments that
opened subsequent to October 28, 2006 added $5.1 million and $0.4 million, respectively, in
expenses in the third quarter of fiscal 2007. These expenses exclude pre-opening and
occupancy (excluding depreciation and amortization) expenses.
-15-
Operating Profit. Operating profit was $34.8 million in the third quarter of fiscal 2007
compared to $25.2 million in the third quarter of fiscal 2006 and increased as a percentage
of net sales to 9.5% in the third quarter of fiscal 2007 from 7.6% in the third quarter of
fiscal 2006. Operating profit as a percentage of net sales was impacted by a decrease in
operating expenses and partially offset by a decrease in gross profit.
Interest Income, Net. Interest income, net for the third quarter of fiscal 2007 was $1.5
million as compared to $1.6 million of net interest income for the third quarter of fiscal
2006. Interest income for the three months ended November 3, 2007 was the result of
investment activity from funds generated from operations and short term investments.
Income Taxes. Our effective tax rate for the third quarter of fiscal 2007 was 38.3%,
compared to 40.3% for the third quarter of fiscal 2006. The decrease in the effective tax
rate was primarily due to a reduction of estimated permanent expenses including state taxes
and an increase of tax exempt income relative to earnings before taxes.
Net Income. For the third quarter of fiscal 2007, net income increased $6.4 million, or
40.2%, over the third quarter of fiscal 2006 and represented 6.1% and 4.8% of net sales,
respectively.
NINE MONTHS ENDED NOVEMBER 3, 2007 COMPARED TO NINE MONTHS ENDED OCTOBER 28, 2006
Net Sales. Sales for the nine months ended November 3, 2007 increased by 13.0%, or $123.1
million, to $1.07 billion from $950.0 million for the nine months ended October 28, 2006.
The increase in DSW sales includes a net increase of 35 DSW stores, 114 non-affiliated
leased departments and seven affiliated leased departments. The DSW store locations and
leased departments opened subsequent to October 28, 2006 added $64.1 million and $36.6
million, respectively, in sales for the nine months ended November 3, 2007. Leased
department sales comprised 12.6% of total net sales in the nine months ended November 3,
2007, compared to 10.2% in the nine months ended October 28, 2006. The increase in sales was
partially offset by the loss of sales from the closed stores and closed leased departments
of $7.7 million.
Our comparable store sales for the nine months ended November 3, 2007 decreased 0.5%, or
$4.2 million, compared to the nine months ended October 28,
2006 due principally to a decline in
customer traffic. For the nine months ended November 3, 2007, DSW comparable store sales
decreased in womens and mens by 1.1% and 1.9%, respectively, and increased in both
athletic and accessories by 3.8%.
Gross Profit. Gross profit increased $20.2 million to $297.3 million in the nine months
ended November 3, 2007 from $277.1 million in the nine months ended October 28, 2006, and
decreased as a percentage of net sales to 27.7% in the nine months ended November 3, 2007
from 29.2% in the nine months ended October 28, 2006. By operating segment, gross profit as
a percentage of sales was:
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|
November 3, |
|
October 28, |
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|
2007 |
|
2006 |
|
DSW Stores |
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|
29.5 |
% |
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|
30.5 |
% |
Leased Departments |
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|
15.4 |
% |
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|
17.5 |
% |
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|
27.7 |
% |
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|
29.2 |
% |
|
The gross profit margin for the nine months ended November 3, 2007 was negatively impacted
by an increase in the markdown rate as a result of significant promotional activity in both
the store and leased department segments and an increase in the store occupancy expense.
This was partially offset by an increase in the initial mark-up. In the leased departments,
the decrease in gross profit as a percentage of sales was driven by markdowns taken in the
stores added in January 2007. Store occupancy expense increased to 13.6% of net sales in
fiscal 2007 from 13.3% of net sales in fiscal 2006, which was the result of costs related to
the Stein Mart stores added since January 2007.
Operating Expenses. For the nine months ended November 3, 2007, operating expenses
increased $16.0 million to $216.9 million from $200.9 million for the nine months ended
October 28, 2006. The DSW stores and leased departments that opened subsequent to October
28, 2006 added $11.0 million and $1.2 million, respectively, in expenses in the nine months
ended November 3, 2007. These expenses exclude pre-opening and occupancy (excluding
depreciation and amortization) expenses.
For the nine months ended November 3, 2007, operating expenses as a percentage of net sales
decreased to 20.2% from 21.2% for the nine months ended October 28, 2006. The decrease in
operating expenses as a percent of net sales was in part the result of a decrease in
marketing expenses as compared to the nine months ended October 28, 2006 due to nonrecurring
expenses related to the change in the loyalty program and decrease of bonus expense of $8.7
million primarily due to
-16-
the
reversal of the current year-to-date bonus accrual. These decreases were partially offset by
increases in home office personnel related expenses and $4.0 million of expenses related to
the start-up of our e-commerce channel.
Operating Profit. Operating profit was $80.3 million for the nine months ended November 3,
2007 compared to $76.2 million for the nine months ended October 28, 2006 and decreased as a
percentage of net sales to 7.5% in the nine months ended November 3, 2007 from 8.0% in the
nine months ended October 28, 2006. Operating profit as a percentage of net sales was
primarily impacted by a decrease in gross profit as a percentage of sales.
Interest Income, Net. Interest income, net for the nine months ended November 3, 2007 was
$5.2 million as compared to $4.9 million of interest income, net for the nine months ended
October 28, 2006. Interest income for the nine months ended November 3, 2007 was the result
of investment activity from funds generated from operations and increased interest income
from short term investments.
Income Taxes. Our effective tax rate for the nine months ended November 3, 2007 was 38.4%,
compared to 39.7% for the nine months ended October 28, 2006. The decrease in the effective
tax rate was primarily due to tax exempt interest income and a reduction of state taxes.
Net Income. For the nine months ended November 3, 2007, net income increased $3.8 million,
or 7.9%, over the nine months ended October 28, 2006 and represented 4.9% and 5.1% of net
sales, respectively.
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 start-up of our e-commerce
channel, the remodeling of existing stores, and infrastructure growth. 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, if needed, under the DSW secured revolving credit facility.
Net working capital increased $12.2 million to $310.9 million at November 3, 2007 from
$298.7 million at February 3, 2007, primarily due to increased inventory related to new
stores opened in fiscal 2006 and 2007, partially offset by an increase in accounts payable.
At both November 3, 2007 and February 3, 2007, the current ratio was 2.9.
For the nine months ended November 3, 2007, our net cash provided by operations was $38.9
million, compared to $67.3 million provided by operations for the nine months ended October
28, 2006. Our net cash flow from operations for the nine months ended November 3, 2007 was
primarily a result of net income, proceeds from tenant and construction allowances and an
increase in accounts payable partially offset by an increase in inventory and a decrease in
accrued expenses.
We expect to spend approximately $100 million for capital expenditures in fiscal 2007.
During the nine months ended November 3, 2007, we had capital expenditures of $70.1 million,
of which $67.3 million was paid during the nine months ended November 3, 2007. Of this
amount, we incurred $30.5 million for new stores and remodels of existing stores, $13.9
million related to the corporate office expansion, $14.2 million related to the start-up of
our e-commerce channel and $11.5 million related to information technology equipment
upgrades and new systems, excluding the e-commerce channel.
Our future capital expenditures will depend heavily on the number of new stores we open, the
number of existing stores we remodel and the timing of these expenditures. We plan to open
at least 35 new DSW stores during fiscal 2007 and at least 30 new stores in each of the next
three fiscal years. During fiscal 2006, the average investment required to open a typical
new DSW store was approximately $1.7 million. Of this amount, gross inventory typically
accounted for approximately $740,000, fixtures and leasehold improvements typically
accounted for approximately $700,000 (prior to tenant and construction allowances) and
pre-opening advertising and other pre-opening expenses typically accounted for
-17-
approximately $210,000. We plan to finance investment in new stores with existing cash and cash flows
from operating activities.
$150 Million Secured Revolving Credit Facility. DSW has a $150 million secured revolving
credit facility that expires July 5, 2010. Under this facility, we and our 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 DSWSWs 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, pay cash dividends,
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 the facility, we must comply with a fixed charge coverage ratio test set forth in the
facility documents. At November 3, 2007 and February 3, 2007, $137.0 million and $136.6
million were available under the $150 million secured revolving credit facility and no
direct borrowings were outstanding. At November 3, 2007 and February 3, 2007, $13.0 million
and $13.4 million in letters of credit were issued and outstanding, respectively.
Retail Ventures Warrants
In connection with the July 2005 amendment of its term loan agreement, Retail Ventures
amended its outstanding warrants to provide Schottenstein Stores Corporation (SSC),
Cerberus Partners L.P. (Cerberus), and Millennium Partners, L.P. (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.
As of November 3, 2007 and 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, 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 the warrants.
Following the completion of any such spin-off, the warrants would 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.
In connection with the July 2005 amendment and restatement of its convertible loan
agreement, Retail Ventures agreed to issue to SSC and Cerberus convertible warrants which
will be exercisable from time to time until the later of June 10, 2009 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 DSW
Common Shares to Retail Ventures shareholders, 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 would be exercisable solely for Retail Ventures common shares. On
June 6, 2007, Retail Ventures issued 1,333,333 of its common shares, without par value, to
Cerberus in connection with Cerberus exercise of its remaining outstanding convertible
warrants that were originally issued by Retail Ventures on July 5, 2005.
SSC may acquire upon exercise of its convertible warrants, Class A Common Shares of DSW from
Retail Ventures. As of November 3, 2007, assuming an exercise price per share of $19.00, SSC
would receive 1,973,685 Class A Common Shares without giving effect to anti-dilution
adjustments, if any, if they exercised their convertible warrants exclusively for DSW Common
Shares.
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Contractual Obligations
DSW had outstanding letters of credit that totaled approximately $13.0 million at November
3, 2007 and $13.4 million at February 3, 2007. 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 payments outside of terms set forth in these arrangements.
As of November 3, 2007, we have entered into various construction commitments, including
capital items to be purchased for projects under construction, or for which a lease has been
signed. Our obligations under these commitments aggregated to approximately $9.3 million as
of November 3, 2007. In addition, we have signed lease agreements for 32 new store
locations, expected to be opened over the next 18 months, with annual rent of approximately
$10.9 million. In connection with the new lease agreements, we will receive approximately
$9.0 million of tenant and construction allowances, which will reimburse us for capital
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
a lease by lease review at lease inception. The Company had no capital leases outstanding
as of November 3, 2007 or February 3, 2007.
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 November 3, 2007, the Company has not entered into any off-balance
sheet arrangements, as that term is defined by the SEC.
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 3 to the Condensed
Consolidated Financial Statements for a discussion of the new accounting standards issued
and implemented during the nine months ended November 3, 2007.
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
investments typically have interest reset periods of 189 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
November 3, 2007 and February 3, 2007, 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, a hypothetical change of 1% in interest
rates would not 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 such term is defined in 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 reasonably likely to materially 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.
We and Retail Ventures contacted and continue to cooperate with law enforcement and other
authorities with regard to this matter. The Company is involved in a putative class action
lawsuit which seeks unspecified monetary damages, credit monitoring and other relief. The
lawsuit seeks to certify a class of consumers that is limited geographically to consumers who
made purchases at certain stores in Ohio.
There can be no assurance that there will not be additional proceedings or claims brought
against us 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 estimated 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 possible settlement of claims 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, 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 to our results of operations or financial condition. As of November 3, 2007, the
balance of the associated accrual for potential exposure was $0.5 million.
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 record 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
record the most likely estimated liability related to the claim. In the opinion of management,
the amount of any potential liability with respect to these proceedings will not be material
to our results of operations or financial condition. As additional information becomes
available, we will assess the potential liability related to our pending litigation and revise
the estimates as needed. Revisions in our estimates and potential liability could materially
impact our results of operations and financial condition.
Item 1A. Risk Factors.
Other than the item below, there have been no material changes to DSWs risk factors set forth
in Part I, Item 1A of our last Annual Report on Form 10-K for the fiscal year ended February
3, 2007.
Retail Ventures is exploring strategic alternatives for its Value City operations, including the
possible sale of some or all of the remaining Value City operations
or the discontinuance of
its operations, which could impact the shared service allocations between DSW and RVI and may
have a material adverse effect on our future financial performance and financial position.
In December 2006, RVI announced that it is exploring
strategic alternatives for its Value City operations. The stated alternatives include a possible sale of some
or all of the Value City operations or the discontinuance of its operations. RVI has stated that there can
be no assurance that this process will result in any specific transaction. On October 3, 2007, RVI announced that Value City entered into an
agreement with Burlington Coat Factory Warehouse Corporation to assign or sublease up to 24 locations such
that the affected stores will close their operations on or before the
end of March 2008. Subsequent to the nine months ended
November 3, 2007, to date, RVI has not
announced the consummation of any additional significant transactions for this segment. RVI has stated that if
no additional significant transaction is achieved and Value City decides to discontinue operations, it
believes that it would be able to close its remaining Value City stores in the same time frame
as the closing of those stores affected by the agreement with Burlington Coat Factory.
DSW is a party to a Shared Services Agreement with RVI pursuant to which
DSW receives services from RVI, and provides services to RVI and its subsidiaries.
The costs associated with many of these shared services are allocated among the
parties based upon the percent of a parties' sales compared to all RVI and DSW sales, or, in some cases,
a usage based charge. In the event that Value City significantly reduces or ceases operations, its allocation
percentage of shared expenses would decrease, which would increase DSWs allocation percentage of shared
service expenses. Additionally, in the event that Value City significantly reduces or ceases operations,
DSW would not be able to allocate as much or any expense to RVI
relating to Value Citys utilization of information technology
and shoe processing services. This increased allocation percentage and reduction in expense allocation could
be material and have a negative effect on DSWs financial position.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) |
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Recent sales of unregistered securities. Not applicable. |
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(b) |
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Use of Proceeds. Not applicable. |
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(c) |
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Purchases of equity securities by the issuer and affiliated purchasers. DSW made no
purchases of its Common Shares during the quarter ended November 3, 2007. |
Limitations
on Payments of Dividends 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, other than dividends paid in stock of the issuer or paid to another
affiliate, 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.
Item 3. Defaults Upon Senior Securities. None.
Item 4. Submission of Matters to a Vote of Security Holders. None.
Item 5. Other Information.
On
July 31, 2007, the Board of Directors approved the DSW Inc.
Nonqualified Deferred Compensation Plan (the Plan), a non-qualified tax-deferred
compensation program which applies to certain executive officers of DSW, including the Chief
Executive Officer and the other executive officers for whom compensation information was
provided in the proxy statement related to DSWs 2007 annual meeting of shareholders. The
Plan provides a tax-favorable vehicle for deferring cash compensation, including base salary
and awards pursuant to the DSW Inc. 2005 Cash Incentive Compensation Plan. Under the Plan, an
executive may defer up to 80% of his or her base salary and up to 90% of annual incentive
pay. DSW may make discretionary matching contributions or other discretionary employer
contributions to the Plan on behalf of participants. Employer contributions made to the Plan
are subject to a vesting schedule determined by DSW at the time such contributions are
credited to a participants account. A participant will become 100% vested in any employer
contributions credited to his or her account upon the participants death, disability or a
change in control (as defined in the Plan). Deferred balances are credited with gains or
losses which mirror the performance of benchmark investment funds selected by the participant
from among a number of available funds. Deferred amounts are paid in a lump sum for scheduled
in-service withdrawals or, at the participants option, in annual installments over a five or
ten-year period upon retirement.
The foregoing description does not purport to be complete and is qualified in its entirety by
reference to the full text of the Plan attached hereto as
Exhibit 10.1.
Item 6. Exhibits. See Index to Exhibits on page 23.
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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: December 13, 2007 |
By: |
/s/ Douglas J. Probst
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Douglas J. Probst |
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Chief Financial Officer
(duly authorized officer and chief financial officer) |
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INDEX TO EXHIBITS
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Exhibit Number |
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Description |
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10.1
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DSW Inc. Nonqualified Deferred
Compensation Plan |
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10.2
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Summary of Director Compensation |
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31.1
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Rule 13a-14(a)/15d-14(a)
Certification of Chief Executive Officer |
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31.2
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Rule 13a-14(a)/15d-14(a)
Certification of Chief Financial Officer |
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32.1
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Section 1350 Certification of
Chief Executive Officer |
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32.2
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Section 1350 Certification of
Chief Financial Officer |
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