DSW Inc. (DSW)

DSW 
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DSW Inc. (DSW)

Q3 2011 Earnings Call

November 22, 2011 8:30 AM ET

Executives

Doug Probst – Chief Financial Officer

Mike MacDonald – Chief Executive Officer

Debbie Ferrée – Vice Chairperson and Chief Merchandising Officer

Analysts

Chris Svezia – Susquehanna Financial Group

Steve Marotta – C.L. King

Claire Gallacher – Auriga Investments

David Mann – Johnson Rice

Scott Krasik – BB&T Capital Markets

Jeff VanSinderen – B.Riley

Jeff Black – Citi

Mark Montagna – Avondale Partners

Patrick McKeever – MKM Partners

Presentation

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to today’s DSW Inc. Third Quarter Fiscal 2011 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session, instructions will be provided at that time for you to queue up for questions. As a reminder, today’s conference is being recorded.

And now, I would like to turn the conference over to Doug Probst, Chief Financial Officer. Please go ahead.

Doug Probst

Thank you and good morning. Welcome to DSW’s third quarter earnings conference call. With me today in Columbus are Mike MacDonald, CEO; and Debbie Ferrée, Vice Chairperson and Chief Merchandising Officer.

Please note that various remarks we make about the 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.

Similar to the format of our presentation in our second quarter call, I’ll be commenting on our reported results for the third quarter and then Mike will provide his comments on our operating performance. Earlier this morning, we issued a press release detailing the results of operations for the quarter ended October 29, 2011.

Our reported net income was $53.7 million and included $13.9 million in items related to our merger with Retail Ventures, Inc., which was completed on May 26, 2011, the settlement of the Premium Income Exchangeable Securities or PIES on September 15, 2011 and related items.

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. Again, similar to our discussion in the second quarter, we thought it would be beneficial to walk you through the details of the costs and benefits associated with the merger and related items, and the specifics of where they are reflected on our P&L, so that you have a clear comparison of our operating performance to last year.

The $13.9 million on RVI merger and related items in the third quarter breaks down into the following five components. First, $300,000 in costs included in SG&A, primarily related to RVI operating expenses.

Second, $20.9 million in a non-cash benefit related to the change in fair value of derivative instrument. This reflects the change in fair value of the PIES from the beginning of the quarter to the settlement date and the change in the fair value of the warrants for the entire quarter. Although, this is a benefit for reported net income in accordance with GAAP, this item is excluded from net income for the reported diluted EPS calculation.

Third, net interest expense of $1.5 million related to the interest on the PIES. Fourth, $300,000 in non-cash income tax expense due to the merger related tax items. And finally, a $5 million impairment charge related to a leased up office facility that DSW inherited in the merger with RVI. The tables in our press release outline these adjustments in more detail.

Now that we have reviewed these items, the remainder of our discussion will refer to our adjusted results. As we have stated before, our guidance for fiscal 2011 has been based and will continue to be based on adjusted results excluding any impact from the merger with RVI and related items.

On an adjusted basis, third quarter 2011 net income increased 12% to $39.8 million or $0.88 per diluted share, compared to net income of $35.5 million or $0.79 per diluted share in the third quarter of 2010. We are very pleased with our third quarter performance which continued the strong growth that we have achieved for the past nine quarters.

Net sales were $530.7 million and comparable sales grew 5.2% on top of the 10.1% comp increase last year, which represents the two-year comp of 15%. By segments, our comps for our DSW business which includes dsw.com were up 5.2% and our comps for the leased business division were up 4.9%.

Our total company merchandise margin rate was 46.4% for the third quarter and represented a 130-basis point improvement compared to last year. In addition to increasing private brand penetration, we were able to achieve this margin expansion by working with our vendors to mitigate costs, selectively passing on price increases and better markdown productivity.

On a total company basis, we achieved occupancy leverage of 40 basis points for a 10.6% occupancy rate primarily due to the increased sales. This was slightly offset by 20 basis points deleverage in our distribution and fulfillment centers to support our size replenishment initiative in dsw.com business. Combined with the increase in merchandise margin, the net effect was a 150-basis point increase in gross profit margin.

Our adjusted SG&A rate as a percentage of sales increase 40 basis points to 21.7% due to increased spend in our new stores and marketing. New store expenses were double what they were in the third quarter of 2010, as we continue to increase our footprint in new and existing markets.

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