DSW Inc. (DSW)

DSW 
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DSW (DSW)

Q2 2011 Earnings Call

August 30, 2011 8:30 am ET

Executives

Deborah Ferree - Vice Chairman and Chief Merchandising Officer

Michael Macdonald - Chief Executive Officer, President and Director

Douglas Probst - Chief Financial Officer and Executive Vice President

Analysts

David Mann - Johnson Rice & Company, L.L.C.

Claire Gallacher - Capstone Investments

Jeff Black - Citigroup Inc

Mark Montagna - Avondale Partners, LLC

Steven Marotta - CL King & Associates, Inc.

Patrick McKeever - MKM Partners LLC

Scott Krasik - BB&T Capital Markets

Jeffrey Van Sinderen - B. Riley & Co., LLC

Christopher Svezia - Susquehanna Financial Group, LLLP

Presentation

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to today's DSW Inc.'s Second Quarter Fiscal 2011 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. And now I would like to turn the conference over to Mr. Doug Probst of DSW. Please go ahead.

Douglas Probst

Thank you, and good morning. Welcome to DSW's Second Quarter Earnings Conference Call. With me today in Columbus are Mr. Mike MacDonald, CEO; and Debbie Ferrée, Vice Chairperson and Chief Merchandising Officer. Please note that various remarks we make about future expectations, plans and prospects of the company constitute forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those listed in today's press release and in our public filings with the SEC.

Earlier this morning, we issued a press release detailing the results of operations for the quarter ended July 30, 2011. Our reported net income was $139.9 million or $3.96 per diluted share on 35.4 million weighted average shares outstanding and included a net benefit of $106.2 million related to our merger with Retail Ventures, Inc., which was completed on May 26, 2011. You can find these items detailed in the condensed consolidated statements of operations and reconciliation of adjusted results attached to our press release issued this morning. However, given the complexity of the transaction, let me share with you the details of the costs and benefits and the specifics of where they are reflected on our P&L so you have a clear comparison of our operating performance to last year.

The $106.2 million net benefit of the merger breaks down into the following 5 components: One, $6.1 million in cost included in the SG&A, primarily related to DSW and RVI transaction costs and other RVI operating expenses; two, $22.9 million in noncash expense related to the change in fair value of derivative instruments. This reflects the change in value of the PIES and warrants. Three, net interest expense of $5.4 million related to interest on the PIES and deferred financing fees on other RVI debt; four, $146.5 million in noncash income tax benefit related to the reversal of valuation allowance and other merger-related tax items; and finally, five, a net $5.8 million charge related primarily to the reversal of RVI's noncontrolling interest in DSW. In total, tax benefit more than offset the other costs and resulted in a combined benefit of $106.2 million. Importantly, most of the constant curve as a result of the merger with RVI will go away after this year.

Our share count for purposes of calculating reported EPS changes the results of weighting RVI and DSW shares pre and post-merger. The 35.4 million shares outstanding is the result of the averaging of the converted RVI shares from May 1 through May 26, the merger date and the DSW shares from May 26 through July 30.

As we have said before, our guidance for the fiscal 2011 has been based and will continue to be based on adjusted results, excluding any costs or benefits related to the merger with RVI. Therefore, on an adjusted basis, second quarter 2011 net income was $33.7 million or $0.74 per diluted share compared to net income of $23.5 million or $0.52 per diluted share in the second quarter of 2010, an increase of over 40%.

Now that we have reviewed these items, the remainder of our discussion will refer to our adjusted results. We are very pleased with our second quarter performance, which continued the strong growth that we have been experiencing for the past 8 quarters. Net sales were $476.3 million and comparable sales grew 12.3% on top of 12.0% comp increase last year, which represents a 2-year comp of 24.3%. By segment, our comps for our DSW business, which includes dsw.com, were up 13.0%; and our comps for the Leased Business division were up 3.7%. Our merchandise margin rate for the second quarter was 45.7% and represented a 60 basis point improvement compared to last year. On a total company basis, we achieved occupancy leverage of 190 basis points or an 11.4% occupancy rate primarily due to the increased sales. This was slightly offset by 10 basis points of deleverage in our distribution and fulfillment centers to support our growing PIES replenishment initiatives and this growing dsw.com business. The net effect was a 240 basis point increase in gross profit to 32.7% of sales.

Our adjusted SG&A rate as a percentage of sales was flat to last year due to increased spend to support our growth initiatives, offsetting fixed cost leverage. Strong sales growth combined with expansion in gross profit margin resulted in a 44% increase in adjusted operating profit to $55 million or 11.6% of net sales. Our adjusted tax rate for the second quarter, which is based on a full year view, was 39.3%. One of the benefits of the merger with RVI is that we have the ability to utilize the NOL assumed in the merger. The utilization of the NOL does not change our effective tax rate, so there will be no impact going forward on our income statement. That said, going forward, we expect to see higher cash balances as we reduce actual cash tax paid. And as mentioned, adjusted EPS increased 42% to $0.74 per diluted share.

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