DSW Inc. - Conference Call Notes

DSW reported fourth quarter earnings of $0.30 a share, $0.02 worse than the consensus estimate.
Net sales for the fourth quarter increased 16% to $402.6 million. Sales were about $18 million better than expected. Same store sales increased 12.9% for the comparable period, versus a decrease of 7.2% a year ago. By segment, comps for the DSW business were up 14.1% for the quarter, which was driven by increases in traffic, conversion, and average unit retail. The comps for the leased business were up 2.7%. The DSW comp does not include sales for DSW.com. However, beginning in the first quarter of 2010, DSW.com sales will be in the DSW segment comp calculation.

The merchandise margin rate for the fourth quarter increased 560 basis points to 44.4%, compared to last year's 38.8%. Throughout the quarter, DSW experienced higher regular priced selling and a lower markdown rate on their clearance inventory. The occupancy expense rate decreased significantly, due to the positive comp in the quarter and a continued focus on negotiating rent concessions from landlords. The combination of a significant increase in merchandise margin and an overall decrease in occupancy expense resulted in a gross profit rate increase of 860 basis points to 29.2%.

SG&A rate decreased 110 basis points to 22.9% in the quarter, due to the increased sales and an overall concerted effort to control expenses. Operating income for the quarter was $25.3 million, or 6.3% of sales, compared to an $11.8 million loss a year ago. Interest income was offset by a charge for an uncertain tax position resulting in a net interest expense of approximately $0.5 million for the quarter. DSW also took a $1.7 million pretax nonoperating charge in the quarter to fully impair its one remaining auction rate security. Net income for the quarter was $13.4 million, compared with a net loss of $7.5 million last year, and diluted earnings per share were $0.30 compared with a loss of $0.17 a year ago.

Balance sheet

At the end of the year, inventories were up approximately 7% on a cost per square foot basis, due to exceptionally low inventories in the previous year that were down 14%. The company is comfortable with its current in-store inventories as it enters the important spring selling season of March and April. DSW invested approximately $22 million of capital into new stores. Cash and short-term investments increased by $133 million in the year, to $289 million, and the company has no debt.

Outlook for 2010

Comps are expected to be in the low single digit range including sales from DSW.com. The company plans to open about 10 new stores in the year. They expect their SG&A rate to improve in 2010, but they do not plan to increase their margin rate off the historical record high of 2009. Earnings per diluted share in the range of $1.35 to $1.45, with all of the increase over last year expected to occur in the first two quarters. The consensus is for share profits of $1.43 this fiscal year.

Other:

Management gave more color on the contrast of its performance in the first and second halves of the year. In the first half comp sales were down 4% on a one-year basis, and they were down 10% on a two-year basis. In the second half, comps were up 11% on a one-year basis, and up 5% on a two-year basis. So the turnaround in comp performance from first to second half was 15 points, regardless of whether you calculate it on a one-year basis or a two-year basis.

In the first half, comp sales declined in women's, men's and athletic footwear. In the second half, all three footwear categories had comp sales increases. Similarly, all geographic store regions were down in the first half, and all had double-digit comp increases in the second half of the year. In the first half, our operating income was down 30% to the prior year. In the second half, our operating income improved by over 600% versus the prior year. The improvement was driven by both strong gross margin dollar growth and meaningful expense improvements in virtually all areas of the business.

In the second half, DSW was continuously chasing additional merchandise receipts to catch up with accelerating sales trends. As a result, inventory turnover accelerated. Sell-through rates on regular priced merchandise improved and proportionately fewer shoes found their way into clearance racks. All of that led to record merchandise margin rate performance.

The significant mid-year turnaround in sales trend was a function of both environmental factors and the successful execution of several initiatives.

First, the shoe category generally performed better than overall retail, just based on the reported sales results of other shoe retailers, and the several positive comments about the shoe category made by other multi-category retailers. Also, value oriented retailers performed much better than overall retail. DSW's positioning in the value sector of the shoe category was a combination that gave them a special opportunity to drive strong sales growth.

Second, the company’s strategy to create category distortion and focus on key items really worked. In the fall, they had a competitively superior selection of boots, and they identified several styles of boots for which they staged multiple deliveries in order to provide a continuous flow of these key items into stores. The result was a blow-away boot season. This category alone accounted for over half of the fall season sales growth.

The company thinks it can repeat the success of the second half of 2009 in the second half of this year by:

1. Continuing to be exceptionally well positioned in the value segment of the fashion footwear space.

2. Continuing to focus on size replenishment, precision marketing, key item penetration, private brand growth, increasing offerings in extended sizes and dimensions, growing men's and accessories, and undergoing store remodeling.

3. At a little over $200 per square foot, DSW feels they're not even close to maxing out on sales productivity.

4. Additional store openings.

5. Further growth from its two-year old e-commerce business.