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EX-32.2 - EXHIBIT 32.2 - DSW Inc.exhibit322q22016.htm
EX-32.1 - EXHIBIT 32.1 - DSW Inc.exhibit321q22016.htm
EX-31.2 - EXHIBIT 31.2 - DSW Inc.exhibit312q22016.htm
EX-31.1 - EXHIBIT 31.1 - DSW Inc.exhibit311q22016.htm
EX-10.1 - EXHIBIT 10.1 - DSW Inc.exhibit101q22016.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 30, 2016

OR

[ ] 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)

Ohio
 
31-0746639
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
810 DSW Drive, Columbus, Ohio
 
43219
(Address of principal executive offices)
 
(Zip Code)
                                    (614) 237-7100
Registrant’s 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
 
 
 
 
þ
Yes
o
No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
 
 
 
Large Accelerated Filer
þ
 
Accelerated Filer
o
 
Non-accelerated Filer
o
 
(Do not check if smaller reporting company)
 
Smaller reporting company
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 August 26, 2016 was 74,501,062 and Class B Common Shares, without par value, as of August 26, 2016 was 7,732,807.





DSW INC.
TABLE OF CONTENTS



Item No.
Page
Part I. Financial Information
 
Item 1. Financial Statements
 
Part II. Other Information
 

    

1


Part I. FINANCIAL INFORMATION
Item 1. Financial Statements

DSW INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share amounts)
(unaudited)
 
Three months ended
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Net sales
$
658,944

 
$
627,206

 
$
1,340,211

 
$
1,282,692

Cost of sales
(472,083
)
 
(435,904
)
 
(948,993
)
 
(878,332
)
Operating expenses
(145,088
)
 
(131,721
)
 
(299,284
)
 
(271,207
)
Change in fair value of contingent consideration
(2,166
)
 

 
(3,611
)
 

Operating profit
39,607

 
59,581

 
88,323

 
133,153

Interest expense
(50
)
 
(40
)
 
(99
)
 
(78
)
Interest income
673

 
792

 
1,243

 
1,750

Interest income, net
623

 
752

 
1,144

 
1,672

Non-operating income (expense)
100

 
(7
)
 
264

 
3,305

Income before income taxes and income (loss) from Town Shoes
40,330

 
60,326


89,731


138,130

Income tax provision
(15,716
)
 
(22,486
)
 
(34,794
)
 
(51,582
)
Income (loss) from Town Shoes
418

 
(230
)
 
109

 
(1,572
)
Net income
$
25,032

 
$
37,610


$
55,046


$
84,976

 
 
 
 
 
 
 
 
Basic and diluted earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
$
0.31

 
$
0.42

 
$
0.67

 
$
0.96

Diluted earnings per share
$
0.30

 
$
0.42

 
$
0.67

 
$
0.95

 
 
 
 
 
 
 
 
Shares used in per share calculations:
 
 
 
 
 
 
 
Basic shares
82,053

 
88,713

 
82,003

 
88,619

Diluted shares
82,655

 
89,693

 
82,691

 
89,660

 
 
 
 
 
 
 
 
Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation (loss) gain
$
(4,903
)
 
$
(8,652
)
 
$
7,246

 
$
(6,838
)
Unrealized net gain (loss) on available-for-sale securities (net of taxes of $14, $6, $130 and $6, respectively)
150

 
50

 
276

 
(311
)
Total comprehensive income
$
20,279

 
$
29,008

 
$
62,568

 
$
77,827
















The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements.

2


DSW INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
ASSETS
 
 
 
 
 
Cash and equivalents
$
62,324

 
$
32,495

 
$
151,007

Short-term investments
103,467

 
226,027

 
140,821

Accounts receivable, net
18,848

 
15,437

 
18,533

Accounts receivable from related parties
81

 
27

 
63

Inventories
556,183

 
484,236

 
505,170

Prepaid expenses and other current assets
30,040

 
37,444

 
31,599

Prepaid rent to related parties
12

 
2

 

Total current assets
770,955

 
795,668

 
847,193

 
 
 
 
 
 
Property and equipment, net
379,643

 
374,241

 
354,477

Long-term investments
77,901

 
71,953

 
179,305

Goodwill
81,043

 
25,899

 
25,899

Deferred income taxes
20,690

 
21,815

 
32,111

Long-term prepaid rent to related parties
821

 
875

 
866

Investment in Town Shoes
17,261

 
21,188

 
21,986

Note receivable from Town Shoes
50,200

 
44,170

 
44,627

Intangible assets
39,316

 
46

 
46

Other assets
21,145

 
13,254

 
7,554

Total assets
$
1,458,975

 
$
1,369,109

 
$
1,514,064

 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
Accounts payable
$
198,584

 
$
214,893

 
$
190,382

Accounts payable to related parties
656

 
733

 
529

Accrued expenses
115,192

 
107,800

 
113,466

Total current liabilities
314,432

 
323,426

 
304,377

 
 
 
 
 
 
Non-current liabilities
143,562

 
140,759

 
144,029

Commitments and contingencies
59,611

 

 

Total liabilities
$
517,605

 
$
464,185

 
$
448,406

 
 
 
 
 
 
Shareholders’ equity:
 
 
 
 
 
Common shares paid in capital, no par value; 250,000 Class A Common Shares authorized; 84,570, 84,396 and 84,047 issued, respectively; 74,359, 74,185 and 81,011 outstanding, respectively; 100,000 Class B Common Shares authorized, 7,733 issued and outstanding
$
936,572

 
$
930,011

 
$
920,682

Preferred Shares, no par value; 100,000 authorized; no shares issued or outstanding

 

 

Treasury shares, at cost, 10,211, 10,211 and 3,036 outstanding, respectively
(266,531
)
 
(266,531
)
 
(86,938
)
Retained earnings
309,503

 
287,140

 
270,510

Basis difference related to acquisition of commonly controlled entity
(24,993
)
 
(24,993
)
 
(24,993
)
Accumulated other comprehensive loss
(13,181
)
 
(20,703
)
 
(13,603
)
Total shareholders’ equity
$
941,370

 
$
904,924

 
$
1,065,658

Total liabilities and shareholders’ equity
$
1,458,975

 
$
1,369,109

 
$
1,514,064


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)
 
 
Number of Shares
 
 
 
Retained earnings
Basis difference related to acquisition of commonly controlled entity
 Accumulated other comprehensive loss


Total
 
 
Class A
Common
Shares
Class B Common
Shares
Treasury Shares
 
Common shares paid in capital
Treasury shares
Balance, January 31, 2015
 
80,666

7,733

3,036

 
$
908,679

$
(86,938
)
$
220,826

$
(24,993
)
$
(6,454
)
$
1,011,120

 
 
 
 
 
 
 
 
 
 
 
 
Net income
 



 


84,976



84,976

Stock-based compensation expense, before related tax effects
 



 
6,729





6,729

Stock units granted
 
31



 
926





926

Exercise of stock options
 
263



 
3,431





3,431

Vesting of restricted stock units, net of settlement of taxes
 
51



 
(1,272
)




(1,272
)
Excess tax benefits related to stock-based compensation
 



 
2,189





2,189

Foreign currency translation
 



 




(6,838
)
(6,838
)
Unrealized net loss on available-for-sale securities (net of taxes of $6)
 



 




(311
)
(311
)
Dividends paid ($0.40 per share)
 



 


(35,292
)


(35,292
)
 
 
 
 
 
 
 
 
 
 
 
 
Balance, August 1, 2015
 
81,011

7,733

3,036

 
$
920,682

$
(86,938
)
$
270,510

$
(24,993
)
$
(13,603
)
$
1,065,658

 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 30, 2016
 
74,185

7,733

10,211

 
$
930,011

$
(266,531
)
$
287,140

$
(24,993
)
$
(20,703
)
$
904,924

 
 
 
 
 
 
 
 
 
 
 
 
Net income
 



 


55,046



55,046

Stock-based compensation expense, before related tax effects
 



 
6,326





6,326

Stock units granted
 
52



 
990





990

Exercise of stock options
 
37



 
429





429

Vesting of restricted stock units, net of settlement of taxes
 
85



 
(1,104
)




(1,104
)
Tax shortfall related to stock-based compensation
 



 
(80
)




(80
)
Foreign currency translation
 



 




7,246

7,246

Unrealized net gain on available-for-sale securities (net of taxes of $130)
 



 




276

276

Dividends paid ($0.40 per share)
 



 


(32,683
)


(32,683
)
 
 
 
 
 
 
 
 
 
 
 
 
Balance, July 30, 2016
 
74,359

7,733

10,211

 
$
936,572

$
(266,531
)
$
309,503

$
(24,993
)
$
(13,181
)
$
941,370
















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)
 
Six months ended
 
July 30, 2016
 
August 1, 2015
Cash flows from operating activities: 
 
 
 
Net income
$
55,046

 
$
84,976

 
 
 
 
Adjustments to reconcile net income to net cash and equivalents provided by operating activities:
Depreciation and amortization
40,389

 
36,712

Stock-based compensation expense
7,316

 
7,655

Deferred income taxes
1,125

 
(1,033
)
(Income) loss from Town Shoes
(109
)
 
1,572

Change in fair value of contingent consideration
3,611

 

Loss on disposal of long-lived assets
702

 
292

Impairment of long-lived assets

 
418

Amortization of investment discounts and premiums
759

 
3,432

Excess tax benefits related to stock-based compensation

 
(2,189
)
Gain on foreign currency exchange rate

 
(3,305
)
 
 
 
 
Change in working capital, assets and liabilities:
 
 
 
Accounts receivable, net
(1,842
)
 
5,811

Inventories
(41,795
)
 
(54,334
)
Prepaid expenses and other current assets
7,946

 
9,051

Accounts payable
(17,059
)
 
17,693

Accrued expenses
3,256

 
1,984

Other
1,799

 
5,835

Net cash and equivalents provided by operating activities
$
61,144

 
$
114,570

 
 
 
 
Cash flows from investing activities:
 
 
 
Cash paid for property and equipment
(51,934
)
 
(50,979
)
Purchases of available-for-sale investments
(57,484
)
 
(105,572
)
Sales of available-for-sale investments
178,980

 
163,808

(Increase) decrease in restricted cash
(467
)
 
2,385

Payment-in-kind interest from Town Shoes
(6,641
)
 
(4,737
)
Acquisition of Ebuys
(60,411
)
 

Net cash and equivalents provided by investing activities
$
2,043

 
$
4,905

 
 
 
 
Cash flows from financing activities:
 
 
 
Proceeds from exercise of stock options
429

 
3,431

Cash paid for income taxes for shares withheld
(1,104
)
 
(1,272
)
Dividends paid
(32,683
)
 
(35,292
)
Excess tax benefits related to stock-based compensation

 
2,189

Net cash and equivalents used in financing activities
$
(33,358
)
 
$
(30,944
)
 
 
 
 
Effect of exchange rate changes on cash balances
$

 
$
3,305

Net increase in cash and equivalents
29,829

 
88,531

Cash and equivalents, beginning of period
32,495

 
59,171

Cash and equivalents, end of period
$
62,324

 
$
151,007

 
 
 
 

5


 
Six months ended
 
July 30, 2016
 
August 1, 2015
Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for income taxes
$
25,685

 
$
43,705

Proceeds from construction and tenant allowances
$
9,179

 
$
14,004

 
 
 
 
Non-cash operating, investing and financing activities:
 
 
 
Balance of accounts payable and accrued expenses due to property and equipment purchases
$
4,944

 
$
8,277

Contingent consideration liability
$
59,611

 
$




















































The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements.

6

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


1. BUSINESS OPERATIONS AND BASIS OF PRESENTATION

Business Operations- DSW Inc. and its wholly owned subsidiaries are herein referred to collectively as DSW Inc. or the “Company”. DSW refers to the DSW segment, which includes DSW stores and dsw.com. DSW Inc. Class A Common Shares are listed on the New York Stock Exchange under the ticker symbol “DSW”. DSW Inc. Class B Common Shares are not listed on a stock exchange but are exchangeable for Class A Common Shares at the election of the shareholder.

DSW Inc. has two reportable segments: the DSW segment, which includes DSW stores and dsw.com, and the Affiliated Business Group (“ABG”) segment. DSW offers a wide assortment of brand name dress, casual and athletic footwear and accessories for women, men and kids. As of July 30, 2016, DSW operated a total of 480 stores located in 42 states, the District of Columbia and Puerto Rico, and dsw.com. During the six months ended July 30, 2016, DSW opened 13 new DSW stores and closed one DSW store.

DSW Inc., through its ABG segment, also partners with three other retailers to help build and optimize their footwear businesses. As of July 30, 2016, ABG supplied merchandise to 281 Stein Mart stores and Steinmart.com, 103 Gordmans stores and Gordmans.com, and one Frugal Fannie’s store. During the six months ended July 30, 2016, ABG added eight new shoe departments and ceased operations in two shoe departments.

DSW Inc. also has an equity investment in Town Shoes Limited ("Town Shoes"). Town Shoes is the market leader in branded footwear in Canada. As of July 30, 2016, Town Shoes operated 186 locations across Canada primarily under The Shoe Company, Shoe Warehouse, Town Shoes and DSW banners, as well as an e-commerce site. As of July 30, 2016, there are 17 DSW Designer Shoe Warehouse stores in Canada operating under a licensing agreement. See Note 4 for further disclosure on the licensing agreement.

On March 4, 2016, the Company acquired Ebuys, Inc. ("Ebuys"), a leading off price footwear and accessories retailer operating in digital marketplaces. Ebuys sells products to customers located in North America, Europe, Australia and Asia. The transaction supports DSW Inc.’s efforts to grow its market share within footwear and accessories domestically and internationally.

Basis of Presentation- The accompanying unaudited condensed consolidated interim financial statements should be read in conjunction with DSW Inc.’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 24, 2016 (the “2015 Annual Report”). In the opinion of management, the unaudited condensed consolidated interim financial statements reflect all adjustments, consisting of normal recurring adjustments, which are necessary to present fairly the condensed consolidated financial position, results of operations and cash flows for the periods presented. The condensed consolidated interim financial statements include the accounts of DSW Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. All amounts are in United States dollars ("USD"), unless otherwise noted.

Prior Period Reclassification- Certain prior period disclosure amounts have been reclassified to conform to current period presentation. Intangible assets are no longer included in other assets and are presented separately in the Company’s balance sheets. Software is no longer included in furniture, fixtures and equipment and is presented separately in the property, plant and equipment footnote (Note 10).

2.     ACQUISITION AND EQUITY METHOD INVESTMENT

Town Shoes- On May 12, 2014, DSW Inc. acquired a 49.2% ownership interest in Town Shoes for $75.1 million Canadian dollars ("CAD") ($68.9 million USD) at the purchase date. As of July 30, 2016, DSW Inc.'s ownership interest is 46.3%. The dilution of the Company's ownership is due to Town Shoes' employee exercise of stock options. DSW Inc.'s initial stake provides 50% voting control and board representation equal to the co-investor.

Additionally, the Town Shoe co-investor holds the option to sell the remaining portion of the company in fiscal 2017 to DSW Inc., and for the subsequent two years. DSW Inc. holds the option to purchase the remaining portion of the company in fiscal 2018, and for the subsequent two years, if the Town Shoe co-investor has not exercised their put option. DSW Inc. purchased $100 million CAD during the first quarter of fiscal 2015 (approximately $79 million USD at purchase date) to take advantage of the strength of the dollar and in anticipation of funding the future purchase of the remaining interest in Town Shoes. The funds are also available to fund other business opportunities or return to U.S. operations, if needed. As this was a cash transaction, the gains or losses related to the purchase of the CAD were recorded in the consolidated statement of operations. During the first quarter of fiscal 2015, the Company recorded $3.3 million in foreign currency exchange gains related to the

7

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


purchase of CAD within non-operating income. The Company invested the CAD in available-for-sale securities in the second quarter of fiscal 2015. The accumulated comprehensive loss was impacted by an increase of $2.9 million for the three months ended July 30, 2016 and a decrease of $5.3 million for the six months ended July 30, 2016.

Ebuys- On March 4, 2016, the Company acquired Ebuys, a digital marketplace and accessories retailer, for a total purchase price of $116.4 million. In addition to cash consideration of $62.5 million, less adjustments for working capital, the purchase price includes future payments that are contingent upon the achievement of specified milestones. The Company will revalue its contingent consideration obligation of $56.0 million each reporting period. Since the acquisition date, Ebuys has recognized revenues of $34.7 million, which is included in the consolidated statement of operations. Goodwill was calculated as the excess of the consideration paid over the net assets recognized and represents the future economic benefits expected to arise from other assets acquired that could not be individually identified and separately recognized. Goodwill related to this acquisition is deductible for income tax purposes.

The purchase price allocation for the Ebuys acquisition is preliminary and subject to change based on the finalization of the detailed valuations. The following table represents the estimate of the allocation of the purchase price (in thousands):

 
Preliminary Purchase Price Allocation as of March 4, 2016
 
Adjustments
 
Updated Preliminary Purchase Price Allocation as of July 30, 2016
Accounts and other receivables
$
1,623

 
$
(361
)
 
$
1,262

Inventory
30,152

 
251

 
30,403

Other current assets
191

 

 
191

Property and equipment
1,221

 
22

 
1,243

Goodwill
54,785

 
359

 
55,144

Other intangible assets
41,301

 
(200
)
 
41,101

Accounts payable and other long-term liabilities
(12,862
)
 
(71
)
 
(12,933
)
Total preliminary purchase price
$
116,411

 
$

 
$
116,411


The preliminary fair value of intangible assets of $41.1 million includes $5.7 million for non-compete agreements, $24.4 million for customer and online retailer relationships, and $11.0 million for trade names.

Per Accounting Standards Codification ("ASC") Topic 805, Business Combinations, the acquirer shall disclose pro-forma financial information as though the business combination had occurred as of the beginning of the comparable prior annual reporting period. For the acquisition of Ebuys in March 2016, pro-forma information was not practicable to obtain as of the time that financial statements were ready for issuance.

In connection with the acquisition of Ebuys, the Company adopted or updated the following significant accounting policies:

Business Combinations- In accordance with ASC Topic 805, Business Combinations, the Company recognizes assets acquired and liabilities assumed in business combinations, including contingent assets and liabilities, based on fair value estimates as of the date of acquisition. The purchase price allocation process requires management to make significant estimates and assumptions with respect to the fair value of any intangible assets acquired, deferred revenues assumed, or contingent consideration within the arrangement. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions or estimates.

Contingent Consideration- The Company agreed to pay additional amounts to the sellers contingent upon achievement of certain negotiated goals. The Company has recognized a liability for this contingent obligation based on its estimated fair value at the date of acquisition with any differences between the acquisition-date fair value and the ultimate settlement of the obligation being recognized as an adjustment to income from operations. For the three and six months ended July 30, 2016, the change in fair value of contingent consideration was $2.2 million and $3.6 million, respectively, which is recognized within the statement of operations.


8

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


Inventories- Merchandise inventories for Ebuys are accounted for using the cost method, where the cost is based on invoice cost.

3.     SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS

A description of the Company's significant accounting policies is included in the 2015 Annual Report.

Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") and the International Accounting Standards Board ("IASB") released Accounting Standards Update ("ASU") 2014-09 on the recognition of revenue from contracts with customers that is designed to create greater comparability for financial statement users across industries and jurisdictions. The standard will take effect for public companies for annual reporting periods beginning after December 15, 2017, including interim reporting periods. The Company has completed an assessment identifying areas of impact for the business, including the Company's loyalty program and co-branded credit card. The Company is currently assessing and evaluating these results and developing an implementation plan, as well as evaluating the transition methods for adoption of the standard.
In April 2015, the FASB released ASU 2015-05 to provide guidance to customers concerning whether a cloud computing arrangement includes a software license. Under this new standard, (1) if a cloud computing arrangement includes a software license, the software license element of the arrangement should be accounted for in a manner consistent with the acquisition of other software licenses, or, (2) if the arrangement does not include a software license, the arrangement should be accounted for as a service contract. The standard took effect for public companies for annual reporting periods beginning after December 15, 2015, including interim reporting periods. The Company has adopted the new standard and is applying the new guidance prospectively.
In January 2016, the FASB released ASU 2016-01, which aims to improve and achieve convergence of the FASB and IASB standards on the accounting for financial instruments. The ASU will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. An entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The Company is currently evaluating the impact of the standard on its financial statements and disclosures.
In February 2016, the FASB released ASU 2016-02, which will increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet. The standard will take effect for public companies for annual reporting periods beginning after December 15, 2018, including interim reporting periods. Early application will be permitted for all entities upon issuance of the final standard. In addition, the FASB has decided to require a lessee to apply a modified retrospective transition approach for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements (the date of initial application). The modified retrospective approach would not require any transition accounting for leases that expired before the date of initial application. The FASB decided to not permit a full retrospective transition approach. The Company is currently evaluating the impact of the standard on its financial statements and disclosures.
In March 2016, the FASB released ASU 2016-07, which will eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The ASU will be effective for fiscal years beginning after December 15, 2016, including interim reporting periods. The update should be applied prospectively upon effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. The Company is currently evaluating the impact of the standard on its financial statements and disclosures.
In March 2016, the FASB released ASU 2016-09, which simplifies the guidance surrounding several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The standard will take effect for public companies for annual reporting periods beginning after December 15, 2016, including interim reporting periods. The Company is currently evaluating the impact of the standard on its financial statements and disclosures.

9

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


4.     RELATED PARTY TRANSACTIONS

Schottenstein Affiliates- As of July 30, 2016, the Schottenstein Affiliates (entities owned or controlled by Jay L. Schottenstein, the executive chairman of the DSW Inc. Board of Directors, and members of his family) beneficially owned approximately 18% of outstanding DSW Inc. Common Shares, representing approximately 51% of the combined voting power of outstanding DSW Inc. Common Shares. As of July 30, 2016, the Schottenstein Affiliates beneficially owned 7.2 million Class A Common Shares and 7.7 million Class B Common Shares.

The Company leases its fulfillment center and certain store locations owned by Schottenstein Affiliates and purchases services and products from Schottenstein Affiliates. Accounts receivable from and payable to affiliates principally result from commercial transactions or affiliate transactions and normally settle in the form of cash in 30 to 60 days. Related party balances are disclosed on the condensed consolidated balance sheets.

License Agreement with Town Shoes- DSW Shoe Warehouse, Inc., a wholly-owned subsidiary of DSW Inc., licenses the use of its trade name and trademark, DSW Designer Shoe Warehouse, to its equity investee, Town Shoes, for a fee calculated as of a fixed percent of sales. The license is exclusive and non-transferable for use in Canada. Town Shoes pays DSW Inc. a percentage of net sales from its Canadian DSW stores on a monthly basis. The Canadian DSW stores operate in a manner similar to DSW stores in the United States and are required to maintain the standards and specifications that DSW uses to operate its own stores. DSW Inc. classifies the royalty fee as net sales.

5.     EARNINGS PER SHARE AND SHAREHOLDERS' EQUITY

Earnings per Share- Basic earnings per share is based on net income and a simple weighted average of common shares outstanding. Diluted earnings per share reflects the potential dilution of common shares adjusted for outstanding stock options, restricted stock units ("RSUs") and performance-based restricted stock units ("PSUs") calculated using the treasury stock method.

The following table is a reconciliation of the number of shares used in the calculation of diluted earnings per share computations for the periods presented:
 
Three months ended
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015

 
 
 
 
 
 
 
 
 
(in thousands)
Weighted average shares outstanding
82,053

 
88,713

 
82,003

 
88,619

Assumed exercise of dilutive stock options
392

 
756

 
442

 
807

Assumed exercise of dilutive RSUs and PSUs
210

 
224

 
246

 
234

Number of shares for computation of diluted earnings per share
82,655

 
89,693


82,691


89,660


Options, RSUs and PSUs- The number of potential common shares that were not included in the computation of dilutive earnings per share because the effect would be anti-dilutive was approximately 3.6 million and 2.0 million for the three months ended July 30, 2016 and August 1, 2015, respectively, and 3.3 million and 1.5 million for the six months ended July 30, 2016 and August 1, 2015, respectively.


10

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


6.     STOCK-BASED COMPENSATION

The DSW Inc. 2014 Long-Term Incentive Plan ("the 2014 Plan") provides for the issuance of equity awards to purchase up to 8.5 million DSW Inc. Common Shares. The Company began issuing shares under the 2014 Plan after the DSW Inc. 2005 Equity Incentive Plan expired in the second quarter of fiscal 2015. The 2014 Plan covers stock options, RSUs, PSUs, director stock units ("DSUs") and stock appreciation rights ("SARs"). Eligible recipients include key employees of DSW Inc. and affiliates, as well as directors. Options generally vest 20% per year on a cumulative basis. Options granted under the 2014 Plan generally remain exercisable for a period of ten years from the date of grant.

Stock-Based Compensation Expense- The following table summarizes stock-based compensation expense:
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
 
 
 
 
(in thousands)
Stock options
$
3,224

 
$
3,626

Restricted stock units
1,870

 
1,401

Performance-based restricted stock units
1,232

 
1,702

Director stock units
990

 
926

Total
$
7,316

 
$
7,655


Stock Options, RSUs, PSUs and DSUs- The following table summarizes all stock-based compensation activity:
 
Six months ended
 
July 30, 2016
 
Stock Options
 
RSUs
 
PSUs
 
DSUs
 
 
 
 
 
 
 
 
 
(in thousands)
Outstanding, beginning of period
3,849

 
372

 
293

 
305

Granted
835

 
181

 
112

 
52

Exercised/units vested
(37
)
 
(83
)
 
(133
)
 
(58
)
Forfeited
(251
)
 
(51
)
 
(27
)
 

Outstanding, end of period
4,396

 
419

 
245

 
299

Exercisable, end of period
2,388

 

 

 

 
The following table summarizes the total compensation cost related to nonvested shares not yet recognized and the weighted average expense recognition period remaining (amounts in thousands):
 
Six months ended
 
July 30, 2016
 
Stock Options
 
RSUs
 
PSUs
Unrecognized compensation cost
$
14,781

 
$
8,201

 
$
4,952

Weighted average expense recognition period
2.2 years

 
2.0 years

 
2.1 years














11

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


The following table illustrates the weighted average assumptions used in the Black-Scholes pricing model for options granted in each of the periods presented:    
 
Six months ended
Assumptions:
July 30, 2016
 
August 1, 2015
Risk-free interest rate
1.5%
 
1.4%
Expected volatility of DSW Inc. Common Shares
36.0%
 
37.9%
Expected option term
5.4 years
 
5.1 years
Dividend yield
3.0%
 
2.1%
Other Data:
 
 
 
Weighted average grant date fair value
$6.59
 
$10.22

Stock Appreciation Rights- DSW Inc. entered into a SARs agreement with a non-employee on June 16, 2014, wherein DSW Inc. granted a total of 0.5 million SARs in two equal tranches with respect to DSW Class A Common Shares. During the three and six months ended August 1, 2015, DSW Inc. recorded a benefit of $1.9 million and expense of $1.6 million, respectively. During the three months ended April 30, 2016 DSW Inc. recorded a benefit of $0.3 million. The unexercised SARs expired in June 2016, and the Company reversed the remaining liability of $0.3 million.

7.     INVESTMENTS

For the available-for-sale bonds and term notes, the carrying value, plus any unrealized gains or losses, equals the fair value. The unrealized holding gains or losses for the available-for-sale securities are reported in other comprehensive income. The Company accounts for its purchases and sales of investments on the trade date of the investment. The classification of available-for-sale securities is based on management's intention of the use of the investments. The Company used a portion of these investments for its acquisition of Ebuys (see Note 2 for additional discussion on the acquisition of Ebuys).

The following table discloses the major categories of the Company's investments as of the dates presented:
 
Short-term investments
 
Long-term investments
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
Carrying value
$
103,051

 
$
225,985

 
$
140,778

 
$
78,068

 
$
72,153

 
$
179,659

Unrealized gains included in accumulated other comprehensive loss
455

 
477

 
91

 
33

 
22

 
14

Unrealized losses included in accumulated other comprehensive loss
(39
)
 
(435
)
 
(48
)
 
(200
)
 
(222
)
 
(368
)
Total investments
$
103,467

 
$
226,027

 
$
140,821

 
$
77,901

 
$
71,953

 
$
179,305


8.     FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Therefore, fair value is a market-based measurement based on assumptions of the market participants. As a basis for these assumptions, the Company classifies its fair value measurements under the following fair value hierarchy:

Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that are publicly accessible. Active markets have frequent transactions with enough volume to provide ongoing pricing information.
Level 2 inputs are other than level 1 inputs that are directly or indirectly observable. These can include unadjusted quoted prices for similar assets or liabilities in active markets, unadjusted quoted prices for identical assets or liabilities in inactive markets or other observable inputs.
Level 3 inputs are unobservable inputs.


12

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


Financial Assets and Liabilities- The following table presents financial assets and liabilities at fair value as of the dates presented:
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015(1)
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and equivalents
$
62,324

 
$
62,324

 

 

 
$
32,495

 
$
32,495

 

 

 
$
151,007

 
$
151,007

 

Short-term investments(a)
103,467

 
120

 
$
103,347

 

 
226,027

 
2,127

 
$
223,900

 

 
140,821

 

 
$
140,821

Long-term investments(a)
77,901

 
314

 
77,587

 

 
71,953

 
181

 
71,772

 

 
179,305

 

 
179,305

Cost method investments(b)
7,250

 

 

 
$
7,250

 
6,000

 

 

 
$
6,000

 

 

 

Note receivable from Town Shoes(c)
43,640

 

 
43,640

 

 
33,311

 

 
33,311

 

 
44,627

 

 
44,627

Total financial assets
$
294,582


$
62,758


$
224,574


$
7,250

 
$
369,786

 
$
34,803


$
328,983


$
6,000

 
$
515,760

 
$
151,007

 
$
364,753

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock appreciation rights(d)

 

 

 

 
$
561

 

 
$
561

 

 
$
3,380

 

 
$
3,380

Contingent consideration(e)
$
59,611

 

 

 
$
59,611

 

 

 

 

 

 

 

Total financial liabilities
$
59,611


$


$


$
59,611


$
561


$


$
561


$

 
$
3,380


$


$
3,380

(1) There were no Level 3 measurements as of August 1, 2015.

(a) Short-term and long-term investments are valued using a market-based approach using Level 2 inputs such as prices of similar assets in active markets.

(b) Cost method investments are valued using Level 3 inputs. The fair value approximates the carrying value as there have been no triggering events that would indicate impairment.

(c) The Company estimated the fair value of the note receivable based upon current interest rates offered on similar instruments. The change in fair value is based on the change in comparable rates on similar instruments. Based on the Company’s intention and ability to hold the note until maturity or the exercise of the put/call option (see Note 2), the carrying value is not other-than-temporarily impaired.

(d) Stock appreciation rights are valued using the Black-Scholes model. See Note 6 for further disclosure on SARs.

(e) Included in the Level 3 liabilities is the contingent consideration liability related to the Company's acquisition of Ebuys. The liability is adjusted to fair value each reporting period. The categorization of the framework used to price the liability is considered Level 3 due to the subjective nature of the unobservable inputs used to determine the fair value.

Level 3 Measurements- Financial assets and liabilities are considered Level 3 when the fair values are determined using pricing models, discounted cash flow methodologies, or similar techniques and at least one significant model assumption or input is unobservable.

The following table presents activity related to Level 3 fair value measurements for cost method investments for the periods presented:
 
 
Fiscal period ended
 
 
July 30, 2016
 
January 30, 2016
 
 
 
 
 
 
 
(in thousands)
Carrying value, beginning of period
 
$
6,000

 

Additional cost method investment
 
1,250

 
$
6,000

Carrying value, end of period
 
$
7,250

 
$
6,000


13

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


The following table presents activity related to Level 3 fair value measurements for DSW Inc.'s contingent consideration liability for the period presented:
 
Six months ended
 
July 30, 2016
 
(in thousands)
Balance, acquisition date of contingent consideration
$
56,000

Change in fair value of contingent consideration
3,611

Balance, end of period
$
59,611


Non-Financial Assets- The Company evaluates the carrying amount of its long-lived assets, primarily property and equipment, and finite-lived intangible assets when events and circumstances warrant such a review to ascertain if any assets have been impaired. For the six months ended July 30, 2016, there was no impairment. For the six months ended August 1, 2015, there was a full impairment related to one store in the ABG segment of $0.4 million, recorded in cost of sales, where the future expected cash flows would not recover the carrying amount of its long-lived assets.

9. DEBT OBLIGATIONS

The Company has a $100 million Secured Credit Facility and a $50 million Letter of Credit Agreement, which are described more fully in the Annual Report on Form 10-K for the fiscal year ended January 30, 2016. As of July 30, 2016, January 30, 2016 and August 1, 2015, the Company had no outstanding borrowings or letters of credit under the Credit Facility with availability of $100 million, $100 million and $50 million, respectively. As of July 30, 2016, January 30, 2016 and August 1, 2015, the Company had $7.9 million, $7.1 million and $8.5 million, respectively, in outstanding letters of credit under the Letter of Credit Agreement, and $8.1 million, $7.7 million and $9.1 million, respectively, in restricted cash on deposit as collateral under the Letter of Credit Agreement. The restricted cash balance is recorded in prepaid expenses and other current assets on the condensed consolidated balance sheets.

10.    PROPERTY AND EQUIPMENT, NET

The balance sheet caption "Property and equipment, net" was comprised of the following as of the periods presented:
 
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
 
 
 
 
 
 
 
 
(in thousands)
Land
 
$
1,110

 
$
1,110

 
$
1,110

Furniture, fixtures and equipment
 
404,626

 
385,780

 
357,255

Software
 
131,675

 
120,567

 
114,351

Buildings, building and leasehold improvements
 
394,702

 
385,861

 
368,976

    Total property and equipment
 
932,113

 
893,318

 
841,692

Accumulated depreciation and amortization
 
(552,470
)
 
(519,077
)
 
(487,215
)
Property and equipment, net
 
$
379,643

 
$
374,241

 
$
354,477


11.     ACCRUED EXPENSES

The balance sheet caption "Accrued expenses" was comprised of the following as of the periods presented:
 
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
 
 
 
 
 
 
 
 
(in thousands)
Gift cards and merchandise credits
 
$
38,062

 
$
43,446

 
$
35,373

Compensation
 
15,184

 
8,042

 
15,862

Taxes
 
18,887

 
17,004

 
17,389

Customer loyalty program
 
11,401

 
10,084

 
15,113

Other accrued expenses (1)
 
31,658

 
29,224

 
29,729

Total accrued expenses
 
$
115,192

 
$
107,800

 
$
113,466


14

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)



(1) Other accrued expenses is comprised of deferred revenue, sales return allowance, stock appreciation rights and various other accrued expenses, including advertising, professional fees and rent.

12.     NON-CURRENT LIABILITIES

The balance sheet caption "Non-current liabilities" was comprised of the following as of the periods presented:
 
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
 
 
 
 
 
 
 
 
(in thousands)
Construction and tenant allowances
 
$
89,460

 
$
86,777

 
$
88,998

Deferred rent
 
37,814

 
37,650

 
37,852

Other non-current liabilities (1)
 
16,288

 
16,332

 
17,179

Total non-current liabilities
 
$
143,562

 
$
140,759

 
$
144,029


(1) Other non-current liabilities is comprised of a reserve for a lease of an office facility assumed in the merger with Retail Ventures, Inc. ("RVI"), income tax reserves and deferred compensation. As of July 30, 2016, the accrual related to the office facility was $8.6 million.

13.    SEGMENT REPORTING

The Company's operating segments are the DSW segment, which includes DSW stores and dsw.com, the ABG segment and Other, which includes Ebuys. The Company has identified such segments based on internal management reporting and responsibilities and measures segment profit as gross profit, which is defined as net sales less cost of sales. All operations are located in the United States and its territories. As of July 30, 2016, the goodwill balance of $81.0 million is made up of $25.9 million recorded in the DSW segment (consistent with prior periods) and $55.1 million recorded in Other related to Ebuys.
 

15

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


 
DSW segment
 
ABG segment
 
Other(1)
 
Total
 
 
 
 
 
 
 
 
 
(in thousands)
Three months ended July 30, 2016
Net sales
$
603,927

 
$
35,446

 
$
19,571

 
$
658,944

Gross profit
177,885

 
7,217

 
1,759

 
186,861

Capital expenditures
25,908

 
145

 
14

 
26,067

 
 
 
 
 
 
 
 
Three months ended August 1, 2015
Net sales
$
592,583

 
$
34,623

 
$

 
$
627,206

Gross profit
184,738

 
6,564

 

 
191,302

Capital expenditures
26,338

 
111

 

 
26,449

 
 
 
 
 
 
 
 
Six months ended July 30, 2016
 
 
 
 
 
 
 
Net sales
$
1,226,959

 
$
78,585

 
$
34,667

 
$
1,340,211

Gross profit
369,304

 
18,030

 
3,884

 
391,218

Capital expenditures
43,258

 
469

 
14

 
43,741

 
 
 
 
 
 
 
 
Six months ended August 1, 2015
 
 
 
 
 
 
 
Net sales
$
1,204,794

 
$
77,898

 
$

 
$
1,282,692

Gross profit
388,800

 
15,560

 

 
404,360

Capital expenditures
53,573

 
218

 

 
53,791

 
 
 
 
 
 
 
 
Total Assets
 
 
 
 
 
 
 
As of July 30, 2016
$
1,077,789

 
$
112,541

 
$
268,645

 
$
1,458,975

As of January 30, 2016
1,126,179

 
105,259

 
137,671

 
1,369,109

As of August 1, 2015
1,254,349

 
116,453

 
143,262

 
1,514,064


(1) Other includes assets, liabilities and expenses of the former RVI (see Note 15), the Company's investment in Town Shoes and Ebuys (see Note 2).

14.    INCOME TAXES

The provision for income taxes is based on the current estimate of the annual effective tax rate and is adjusted as necessary for quarterly events. The effective tax rate reflects the impact of federal, state and local, and foreign taxes, as well as tax on the income or loss from Town Shoes. The effective tax rate for the three and six months ended July 30, 2016 is 38.6% and 38.7%, respectively. The effective tax rate for the three and six months ended August 1, 2015 was 37.4% and 37.8%, respectively.

15.    COMMITMENTS AND CONTINGENCIES

Legal Proceedings- The Company is involved in various legal proceedings that are incidental to the conduct of its business. Although it is not possible to predict with certainty the eventual outcome of any litigation, in the opinion of management, the amount of any potential liability with respect to current legal proceedings will not be material to 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.

Merger with Retail Ventures, Inc. ("the Merger")- As of the effective time of the Merger, a subsidiary of DSW Inc. assumed the obligations under RVI’s guarantees related to discontinued operations. DSW Inc. may become subject to various risks related to guarantees and in certain circumstances may be responsible for certain other liabilities related to these discontinued operations. In the first quarter of fiscal 2015, the Company recorded a $2.0 million benefit from the final distribution from the bankruptcy debtor's estates related to Filene's Basement's bankruptcy in 2011 within the consolidated statement of operations.

Contractual Obligations- As of July 30, 2016, the Company has entered into various construction commitments, including capital items to be purchased for projects that were under construction, or for which a lease has been signed. The Company's

16

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


obligations under these commitments were $5.8 million as of July 30, 2016. In addition, the Company has signed lease agreements for 28 new DSW store locations, expected to be opened in fiscal 2016 and 2017, with total annualized rent of $7.9 million. In connection with the new lease agreements, the Company will receive a total of $11.5 million of construction and tenant allowance reimbursements for expenditures at these locations.

16.    SUBSEQUENT EVENTS

Dividends- On August 30, 2016, DSW Inc.'s Board of Directors declared a quarterly cash dividend payment of $0.20 per share. The dividend will be paid on September 30, 2016 to shareholders of record at the close of business on September 16, 2016. The payment of any future dividends is at the discretion of the Board of Directors and is based on future earnings, cash flow, financial condition, capital requirements, changes in taxation laws, general economic condition and any other relevant factors.

International Franchise Agreement- On August 2, 2016, DSW Inc. signed an agreement with Apparel Group as an exclusive franchise partner in the Middle East. The agreement will expand DSW by up to 40 stores across the territory, both in malls and on high street locations, with the first stores opening in fiscal 2017.



17


Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations

All references to “we,” “us,” “our,” or the “Company” in this Quarterly Report on Form 10-Q mean DSW Inc. and its wholly owned subsidiaries. DSW refers to the DSW segment, which includes DSW stores and dsw.com. DSW Inc. Class A Common Shares are listed for trading under the ticker symbol “DSW” on the New York Stock Exchange.

Company Overview

DSW is the destination for fabulous brands at a great value every single day. With a breathtaking assortment of shoes, handbags and accessories for women, men and kids in 480 stores nationwide and on dsw.com, DSW strives to delight customers with finding the perfect shoe at an incredible price. Our DSW stores average approximately 21,000 square feet and carry approximately 23,000 pairs of shoes. In addition, our DSW Rewards loyalty program means shopping comes with perks; members earn points towards certificates every time they purchase. We believe this combination of assortment, convenience and value differentiates us from our competitors and appeals to consumers from a broad range of socioeconomic and demographic backgrounds.

As a segment of DSW Inc., the Affiliated Business Group ("ABG") partners with multi-category retailers to develop strategies and business models for targeted shoe assortments. ABG provides service to 385 store locations and two e-commerce channels through leased partnerships with Stein Mart, Gordmans and Frugal Fannie's.

DSW Inc. also has an equity investment in Town Shoes Limited ("Town Shoes"). Town Shoes is the market leader in branded footwear in Canada, with sales of approximately $160 million CAD for the six months ended the second quarter of fiscal 2016. As of July 30, 2016, Town Shoes operated 186 locations across Canada, primarily under The Shoe Company, Shoe Warehouse, Town Shoes and DSW banners, as well as an e-commerce site. In 2014, DSW Inc. entered into a licensing agreement with Town Shoes, which allows Town Shoes to use the DSW Designer Shoe Warehouse trade name for their new larger concept Canadian stores. As of July 30, 2016, there are 17 DSW Designer Shoe Warehouse stores in Canada.

On March 4, 2016, the Company acquired Ebuys, Inc. ("Ebuys"), a leading off price footwear and accessories retailer operating in digital marketplaces. Ebuys sells products to customers located in North America, Europe, Australia and Asia. The transaction supports DSW Inc.’s efforts to grow its market share within footwear and accessories domestically and internationally.

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. Such forward-looking statements can be identified 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 current plans, estimates, 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 factors described under “Part I, Item 1A. Risk Factors,” in our Form 10-K filed on March 24, 2016 and within this Form 10-Q, some important factors that could cause actual results, performance or achievements 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 strong relationships with our vendors;
our ability to anticipate and respond to fashion trends;
our success in meeting customer expectations;
disruption of our distribution and/or fulfillment operations;
continuation of agreements and the financial condition of our affiliated business and international partners;
fluctuation of our comparable sales and quarterly financial performance;
risks related to our information systems and data;
failure to retain our key executives or attract qualified new personnel;
our competitiveness with respect to style, price, brand availability and customer service;
our reliance on our DSW Rewards program and marketing to drive traffic, sales and customer loyalty;
uncertain general economic conditions;
our reliance on foreign sources for merchandise and risks inherent to international trade;

18


risks related to our handling of sensitive and confidential data;
risks related to leases of our properties;
risks related to prior and current acquisitions;
foreign currency exchange risk; and
risks related to our cash and investments.

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 have projected. Furthermore, new factors emerge from time to time and it is not possible for management to predict all such factors, nor can management 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, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

Results of Operations

The following table includes selected components of our results of operations, expressed as percentages of net sales:    
 
Three months ended
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Net sales
100.0%
 
100.0%
 
100.0%
 
100.0%
Cost of sales
(71.6)
 
(69.5)
 
(70.8)
 
(68.5)
Gross profit
28.4
 
30.5
 
29.2
 
31.5
Operating expenses
(22.0)
 
(21.0)
 
(22.3)
 
(21.1)
Change in fair value of contingent consideration
(0.4)
 
 
(0.3)
 
Operating profit
6.0
 
9.5

6.6

10.4
Interest income, net
0.1
 
0.1
 
0.1
 
0.1
Non-operating income (expense)
0.0
 
0.0
 
0.0
 
0.3
Income before income taxes and income (loss) from Town Shoes
6.1
 
9.6
 
6.7
 
10.8
Income tax provision
(2.4)
 
(3.6)
 
(2.6)
 
(4.1)
Income (loss) from Town Shoes
0.1
 
0.0
 
0.0
 
(0.1)
Net income
3.8%

6.0%

4.1%

6.6%

Overview. Our reported net income for the six months ended July 30, 2016 was $55.0 million, or $0.67 per diluted share, including pre-tax charges of $8.4 million, or $0.06 per share, from purchase accounting, transaction costs and fair market value accounting charges related to the Ebuys acquisition, and $2.7 million, or $0.02 per share, from restructuring costs. This compares against last year’s net income of $85.0 million, or $0.95 per diluted share.

THREE AND SIX MONTHS ENDED JULY 30, 2016 COMPARED TO THREE AND SIX MONTHS ENDED AUGUST 1, 2015

Net Sales. Net sales for the second quarter of fiscal 2016 increased 5.1% compared to the second quarter of fiscal 2015. Net sales for the six months ended July 30, 2016 increased 4.5% compared to the six months ended August 1, 2015. The following table summarizes the net change in our net sales (in millions):
 
Three months ended
 
Six months ended
 
July 30, 2016
 
July 30, 2016
 
 
 
 
 
(in millions)
Net sales for the same period last year
$
627.2

 
$
1,282.7

Decrease in comparable sales
(7.4
)
 
(17.6
)
Increase due to Ebuys sales
19.6

 
34.7

Net increase from non-comparable and closed store sales
19.5

 
40.4

Net sales for the current period
$
658.9

 
$
1,340.2



19


The following table summarizes our net sales by segment and in total:
 
Three months ended
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
 
 
 
 
 
 
 
 
 
(in thousands)
DSW segment
$
603,927

 
$
592,583

 
$
1,226,959

 
$
1,204,794

ABG segment
35,446

 
34,623

 
78,585

 
77,898

Other(1)
19,571

 

 
34,667

 

Total DSW Inc.
$
658,944

 
$
627,206

 
$
1,340,211

 
$
1,282,692


(1) Other represents net sales for Ebuys.

The following table summarizes our comparable sales change by reportable segment and in total:
 
Three months ended
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
DSW segment
(1.2)%
 
1.9%
 
(1.3)%
 
3.5%
ABG segment
(1.0)%
 
0.7%
 
(2.3)%
 
3.1%
Total DSW Inc.
(1.2)%
 
1.8%
 
(1.4)%
 
3.5%

Our increase in total net sales for the three and six months ended July 30, 2016 was driven by the DSW segment and incremental sales from the acquisition of Ebuys. For the three and six months ended July 30, 2016, transactions for the DSW segment increased in the low single digits, offset by a low single digit decline in average dollar sales.

Sales for the ABG segment remained relatively flat for the three and six months ended July 30, 2016, while revenue from our Ebuys acquisition (included in Other above) contributed $19.6 million and $34.7 million for the three and six months ended July 30, 2016, respectively.

For the second quarter of fiscal 2016, the combined athletic and non-athletic comparable sales for men and women was consistent with the DSW segment, led by the demand for athletic footwear. During the second quarter of fiscal 2016, we introduced a new kids assortment in approximately half the chain after a successful pilot.

Gross Profit. Gross profit is defined as net sales less cost of sales. Gross profit decreased as a percentage of net sales to 28.4% in the second quarter of fiscal 2016 from 30.5% in the second quarter of fiscal 2015. Gross profit decreased as a percentage of net sales to 29.2% for the six months ended July 30, 2016 from 31.5% for the six months ended August 1, 2015. By segment and in total, gross profit as a percentage of net sales was:
 
Three months ended
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
DSW segment
29.5%
 
31.2%
 
30.1%
 
32.3%
ABG segment
20.4%
 
19.0%
 
22.9%
 
20.0%
Other(1)
9.0%
 
—%
 
11.2%
 
—%
Total DSW Inc.
28.4%
 
30.5%
 
29.2%
 
31.5%

(1) Other represents gross profit attributable to Ebuys.











20


The reconciliation of each segment's merchandise margin (as described below under "Non-GAAP Measures", is a measure not under generally accepted accounting principles ("GAAP")) to gross profit (the most comparable GAAP measure) as a percentage of net sales is provided below:
 
Three months ended
 
Six months ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
DSW segment gross profit
29.5
%
 
31.2
%
 
30.1
%
 
32.3
%
Store occupancy expense
11.5
%
 
11.3
%
 
11.2
%
 
10.8
%
Distribution and fulfillment expenses
2.1
%
 
2.0
%
 
2.2
%
 
2.0
%
DSW segment merchandise margin
43.1
%
 
44.5
%
 
43.5
%
 
45.1
%
 
 
 
 
 
 
 
 
ABG segment gross profit
20.4
%
 
19.0
%
 
22.9
%
 
20.0
%
Occupancy fees
20.2
%
 
19.9
%
 
20.3
%
 
22.3
%
Distribution and fulfillment expenses
1.1
%
 
1.1
%
 
1.1
%
 
1.1
%
ABG segment merchandise margin
41.7
%
 
40.0
%
 
44.3
%
 
43.4
%
 
 
 
 
 
 
 
 
Other gross profit(1)
9.0
%
 
%
 
11.2
%
 
%
Marketplace fees
12.0
%
 
%
 
11.5
%
 
%
Distribution and fulfillment expenses
13.0
%
 
%
 
11.5