ITEM 1B.
UNRESOLVED STAFF COMMENTS.
None.
All DSW stores, distribution and fulfillment centers, a trailer parking lot and our office facilities are leased or subleased. As of January 29, 2011, the Company leased or subleased 21 DSW stores, the corporate office, the primary distribution center, a trailer parking lot and the dsw.com fulfillment center, from entities affiliated with SSC. The remaining DSW stores are leased from unrelated entities. Most of the DSW store leases provide for a minimum annual rent plus a percentage of gross sales over specified breakpoints and are for a fixed term with options for three to five extension periods, each of which is for a period of four or five years, exercisable at our option.
As of January 29, 2011, we operated 311 DSW stores in 39 states in the United States. The following table shows the number of DSW stores by state.
DSW’s primary distribution facility, its principal executive office and its dsw.com fulfillment center are located in Columbus, Ohio. The lease for DSW’s distribution center and its executive office space expires in December 2021 and has three renewal options with terms of five years each. The lease for DSW’s dsw.com fulfillment center expires in September 2017 and has two renewal options with terms of five years each.
Value City Litigation
On October 25, 2010, Value City Holdings, Inc., Value City Department Stores LLC, Value City Department Stores Services, Inc., Value City of Michigan, Inc., Gramex Retail Stores, Inc., GB Retailers, Inc., J.S. Overland Delivery, Inc., Retail Ventures Jewelry, Inc., and VCHI Acquisition Co. (collectively, “Debtors”) filed a complaint against RVI, Retail Ventures Services, Inc., and DSW (the “Defendants”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). The complaint relates to Debtors’ pending voluntary cases under Chapter 11 of the Bankruptcy Code.
In the complaint, Debtors have alleged claims for avoidable preferences, fraudulent transfer, receipt of illegal dividends, recovery of assets, unjust enrichment and breach of contract. The claims are related to transfers made by Debtors to the Defendants during the one year period preceding Debtors’ filing of voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code on October 26, 2008. Debtors have sought damages that total approximately $373.4 million.
On January 20, 2011, the Bankruptcy Court approved a December 21, 2010 settlement between the Debtors and the Defendants, which became final and non-appealable as of February 4, 2011, and in which Value City agreed to fully release the Defendants from all claims and obligations. The Defendants have paid to Value City the settlement payment of $3.6 million and Value City has filed a dismissal of the complaint.
Litigation Relating to the Merger
Purported shareholders of RVI have filed two putative shareholder class action lawsuits in an Ohio state court against RVI and its directors and in one case, its chief executive officer (referred to collectively as the RVI Defendants), and DSW and in one case DSW Merger LLC (referred to collectively as the DSW defendants). The lawsuits allege, among other things, that RVI and its directors breached their fiduciary duties by approving the Merger Agreement, and that in one case, RVI’s chief executive officer and DSW, and in the other that RVI and DSW, aided and abetted in these alleged breaches of fiduciary duty. The complaints seek, among other things, to enjoin the shareholder vote on the Merger, as well as monetary damages. While the RVI Defendants and DSW defendants believe the lawsuits are without merit and intend to defend vigorously against these claims, the outcome of any such litigation is inherently uncertain. If a dismissal is not granted or a settlement is not reached, the lawsuit could prevent or delay the completion of the Merger and result in substantial costs to RVI and DSW. In addition, the defense or settlement of any lawsuit or claim that remains unresolved at the time the Merger closes could adversely affect RVI’s and DSW’s business, financial condition or results of operations.
The Company is also involved in various 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 Company’s 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 Company’s results of operations and financial condition.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our Common Shares are listed for trading under the ticker symbol “RVI” on the New York Stock Exchange. The following table sets forth the high and low sales prices of our Common Shares as reported on the NYSE Composite Tape during the periods indicated. As of March 1, 2011, there were 601 holders of record of our Common Shares.
Retail Ventures made no purchases of its Common Shares during the fourth quarter of the 2010 fiscal year.
We have paid no cash dividends in the two most recent fiscal years and we do not anticipate paying cash dividends on our Common Shares during fiscal 2011. Presently, we expect that all of DSW’s future earnings will be retained for development of its businesses while all of RVI’s future earnings will be used for general corporate purposes and continuing expenses. 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. DSW’s credit facility restricts the payment of dividends by DSW or its subsidiaries, up to the aggregate amount of up to 50% of the previous year’s net income, for a maximum of $50.0 million, provided that DSW meets the minimum cash requirement set forth in its facility.
PERFORMANCE GRAPH
The following graph sets forth the Company’s total cumulative shareholder return as compared to the S&P Midcap 400 Index and the S&P Retailing Index, both of which are published indexes. This comparison includes the period beginning January 28, 2006 and ending on January 29, 2011.
The comparison of the cumulative total returns for each investment assumes that $100 was invested on January 28, 2006, and that all dividends earned on such investment were reinvested.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA.
The following table sets forth for the periods indicated various selected financial information. Such selected consolidated financial data should be read in conjunction with the consolidated financial statements of Retail Ventures, including the notes thereto, set forth in Item 8 of this Annual Report on Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in Item 7
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This management’s discussion and analysis of financial condition and results of operations (“Management’s Discussion and Analysis”) contains forward-looking statements that involve risks and uncertainties. Please see “Cautionary Statement Regarding Forward-Looking Information for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” on page 3 of this Annual Report on Form 10-K for a discussion of the uncertainties, risks and assumptions associated with these statements. You should read the following discussion in conjunction with our historical consolidated financial statements and the notes thereto appearing elsewhere in this Annual Report on Form 10-K. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under “Risk Factors” and included elsewhere in this Annual Report on Form 10-K.
OVERVIEW
Retail Ventures is a holding company and all our operations are conducted through our subsidiaries. RVI has no net sales on a standalone basis. Retail Ventures has two operating segments: DSW and Corporate as of January 29, 2011. DSW is a leading U. S. branded footwear specialty retailer operating 311 shoe stores in 39 states as of January 29, 2011. DSW offers a wide assortment of better-branded merchandise. DSW’s typical customers are brand-, value-, quality- and style-conscious shoppers who have a passion for footwear and accessories. The Corporate segment consists of all corporate assets, liabilities and expenses that are not allocated to the DSW segment, debt-related expenses and income on investments.
On July 5, 2005, DSW completed an initial public offering (“IPO”) of 16,171,875 Class A Common Shares sold at a price to the public of $19.00 per share and raising net proceeds of $285.8 million, net of the underwriters’ commission and before expenses of approximately $7.8 million. Associated with this transaction, a deferred tax liability of $65.5 million was recorded. As of January 29, 2011, Retail Ventures owned Class B Common Shares of DSW representing approximately 62.0% of DSW’s outstanding Common Shares, including DSW director stock units, and approximately 92.9% of the combined voting power of such shares. DSW is a controlled subsidiary of Retail Ventures and its Class A Common Shares are traded on the New York Stock Exchange under the symbol “DSW.” Retail Ventures accounted for the sale of DSW as a capital transaction.
On January 23, 2008, Retail Ventures disposed of an 81% ownership interest in its Value City Department Stores (“Value City”) business to VCHI Acquisition Co., a newly formed entity owned by VCDS Acquisition Holdings, LLC, Emerald Capital Management LLC and Crystal Value, LLC. Retail Ventures received no net cash proceeds from the sale, paid a fee of $0.5 million to the purchaser, and recognized an after-tax loss of $64.5 million on the transaction as of January 29, 2011. As part of the transaction, Retail Ventures, Inc. issued warrants to VCHI Acquisition Co. to purchase 150,000 RVI Common Shares, at an exercise price of $10.00 per share, and exercisable within 18 months of January 23, 2008. The warrants expired in June 2009. To facilitate the change in ownership and operation of Value City Department Stores, Retail Ventures agreed to provide or arrange for the provision of certain transition services principally related to information technology, finance and human resources to Value City Department Stores for a period of one year unless otherwise extended by both parties. On October 26, 2008, Value City filed for bankruptcy protection and announced that it would close its remaining stores. The Company negotiated an agreement with Value City to continue to provide services post bankruptcy filing, including risk management, financial services, benefits administration, payroll and information technology services, in exchange for a weekly payment.
On April 21, 2009, Retail Ventures disposed of Filene’s Basement, Inc. and certain related entities to FB II Acquisition Corp., a newly formed entity owned by Buxbaum Holdings, Inc. (“Buxbaum”). Retail Ventures did not realize any cash proceeds from this transaction, agreed to pay a fee of $1.3 million to Buxbaum, which has been paid, and has reimbursed $0.4 million of Buxbaum’s costs associated with the transaction. Retail Ventures has also agreed to indemnify Buxbaum, FB II Acquisition Corp. and their owners against certain liabilities. Retail Ventures has recognized an after-tax gain of $85.8 million on the transaction as of January 29, 2011. On May 4, 2009, Filene’s Basement filed for bankruptcy protection. On June 18, 2009, following bankruptcy court approval, SYL LLC, a subsidiary of Syms Corp (“Syms”), purchased certain assets of Filene’s Basement. All references to “liquidating Filene’s Basement” refer to the debtor, formerly known as Filene’s Basement Inc., and its debtor subsidiaries remaining after the asset purchase by a subsidiary of Syms. All references to “New Filene’s Basement” refer to the stores operated by Syms. The Company negotiated with Syms to provide transition services in exchange for payment. On September 25, 2009, RVI and DSW entered into a settlement agreement with liquidating Filene’s Basement and its related debtors and the Official Committee of Unsecured Creditors appointed in the Chapter 11 case for the debtors. On November 3, 2009, the settlement agreement was approved by the Bankruptcy Court for the District of Delaware. As a result of the court’s approval of the settlement agreement, RVI’s claims in respect of $52.6 million in notes receivable from liquidating Filene’s Basement were released; RVI assumed the rights and obligations related to (and agreed to indemnify liquidating Filene’s Basement with regard to certain matters arising out of) the liquidating Filene’s Basement defined benefit pension plan; and liquidating Filene’s Basement and the creditors’ committee agreed to allow RVI certain general
unsecured claims representing (i) $6.36 million for amounts paid on account of guarantees provided by RVI to certain factors of liquidating Filene’s Basement; (ii) $3.0 million for amounts owed by liquidating Filene’s Basement to RVI for inventory purchased for liquidating Filene’s Basement prior to April 21, 2009; (iii) $2.3 million attributable to a negotiated settlement of amounts paid on account of guarantees provided by RVI to landlords of liquidating Filene’s Basement, amounts paid or required to be paid by RVI in connection with certain litigation to which RVI and liquidating Filene’s Basement are both parties and any additional amounts that may be owed by liquidating Filene’s Basement to RVI. DSW’s allowed general unsecured claim under the settlement agreement is $0.5 million. The parties also agreed to certain provisions affecting the proper allocation of proceeds paid to RVI or liquidating Filene’s Basement in connection with specified third party litigation and to certain provisions related to the debtors’ recovery from third parties that are the beneficiaries of letters of credit or hold collateral related to workers’ compensation claims. The settlement agreement also provides for certain mutual releases among the debtors, the creditors’ committee, RVI, DSW and other parties. Although the settlement agreement provides that RVI will have certain allowed claims against the debtors, there can be no assurance as to whether RVI will ultimately recover all of the amounts in connection with these claims. A plan of reorganization of the debtors was confirmed by the court on January 26, 2010, and an initial distribution from the debtors’ estates of $7.3 million to RVI and $0.3 million to DSW has been made. However, there can be no assurance as to timing or the amount of any additional distribution in respect of its claims (or whether RVI will recover any of the remainder of the amounts in connection with its claims). In addition, as a result of the releases provided by the settlement agreement, RVI has relinquished the right to pursue additional claims, which may include unknown or unmatured claims, against the debtors.
As of January 29, 2011, the Company is no longer providing transition services to Value City or Syms.
We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of the Company as a whole. This discussion should be read in conjunction with our financial statements and accompanying notes included in this Annual Report on Form 10-K.
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis discusses the results of operations and financial condition as reflected in our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles, or GAAP. As discussed in Note 1 to our consolidated financial statements, the preparation of financial statements in conformity with generally accepted accounting principles 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 consolidated financial statements and reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including, but not limited to, those related to fair value of derivatives, inventory valuation, depreciation, amortization, recoverability of long-lived assets including intangible assets, the calculation of retirement benefits, estimates for self-insurance reserves for health and welfare, workers’ compensation and casualty insurance, income taxes, contingencies and litigation. Management bases its estimates and judgments on its historical experience and other relevant factors, 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 the consolidated financial statements.
We believe the following represent the most critical estimates and assumptions, among others, used in the preparation of our consolidated financial statements. We have discussed the selection, application and disclosure of the critical accounting policies with our Audit Committee.
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Revenue recognition. Revenues from merchandise sales are recognized upon customer receipt of merchandise are net of returns through period end and sales tax and are not recognized until collectability is reasonably assured. For dsw.com, we estimate a time lag for shipments to record revenue when the customer receives the goods. We believe a one day change in our estimate would not materially impact our revenue. Net sales also include revenue from shipping and handling while the related costs are included in cost of sales.
Revenue from gift cards is deferred and the revenue is recognized upon redemption of the gift card. Our policy is to recognize income from breakage of gift cards when the likelihood of redemption of the gift card is remote. Miscellaneous income is included in selling, general and administrative expenses. We recognized $1.1 million, $1.1 million and $0.8 million as other operating income from gift card breakage during fiscal 2010, 2009 and 2008, respectively, excluding discontinued operations.
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Cost of sales and merchandise inventories. Merchandise inventories are stated at the net realizable value, 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 margins are calculated by applying a calculated cost to retail ratio to the retail value of inventories. The cost of the inventory reflected on the 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, which are reductions in prices due to customers’ perception of value. Accordingly, earnings are negatively impacted as merchandise is marked down prior to sale.
Inherent in the calculation of inventories are certain significant management judgments and estimates, including setting the original merchandise retail value or markon, markups of initial prices established, markdowns and estimates of losses between physical inventory counts or shrinkage, which, combined with the averaging process within the retail method, can significantly impact the ending inventory valuation at cost, and the resulting gross profit.
DSW records a reduction to inventories and charge to cost of sales for shrinkage. Shrinkage is calculated as a percentage of sales from the last physical inventory date. DSW estimates are based on both our historical experience as well as recent physical inventory results. Physical inventory counts are taken on an annual basis and have supported our shrinkage estimates. If the estimate of shrinkage, on a cost basis, were to increase or decrease 0.5% as a percentage of net sales, it would result in a decrease or increase of approximately $3.9 million to operating profit.
Markdowns establish a new cost basis for inventory. Changes in facts or circumstances do not result in the reversal of previously recorded markdowns or an increase in the newly established cost basis. The markdown reserve requires management to make assumptions regarding customer preferences, fashion trends and consumer demand.
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Investments. DSW’s investments are valued using a market based approach using level 1 and 2 inputs. DSW’s equity investment is recorded at cost and reviewed for impairment using an income approach valuation model that uses level 3 inputs such as the financial condition and future prospects of the entity.
DSW evaluates their investments for impairment and whether impairment is other-than-temporary. In determining whether impairment has occurred, DSW reviews information about the underlying investment that is publicly available and assesses their ability to hold the securities for the foreseeable future. Based on the nature of the impairment(s), DSW would record temporary impairments as unrealized losses in other comprehensive income or other-than-temporary impairments in earnings. The investment is written down to its current market value at the time the impairment is deemed to have occurred.
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Asset impairment and long-lived assets. We 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 or asset group is considered impaired when the carrying value of the asset or asset group 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 or asset group over its fair value, based on projected discounted cash flows using a discount rate determined by management. Any impairment loss realized is included in selling, general and administrative expense. We believe as of January 29, 2011 that the long-lived assets’ carrying amounts and useful lives are 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 casualty insurance costs that are self-insured programs. Self-insurance reserves include actuarial estimates of both claims filed, carried at their expected ultimate settlement value, and claims incurred but not yet reported. Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet date. Health and welfare estimates are calculated utilizing claims development estimates based on historical experience and other factors. Workers’ compensation and general liability insurance estimates are calculated utilizing claims development estimates based on historical experience and other factors. We have purchased stop loss insurance to limit our exposure to any significant exposure on a per person basis for health and welfare and on a per claim basis for workers’ compensation and casualty insurance. Although we do not anticipate the amounts ultimately paid will differ significantly from our estimates, self-insurance reserves could be affected if future claim experience differs significantly from the historical trends and the actuarial assumptions. For example, for workers’ compensation and liability future 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.
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Customer loyalty program. DSW maintains a customer loyalty program for the DSW stores and dsw.com in which program members earn reward certificates that result in discounts on future purchases. Upon reaching the target-earned threshold, the members receive reward certificates for these discounts which expire six months after being issued. DSW accrues the anticipated redemptions of the discount earned at the time of the initial purchase. To estimate these costs, DSW is required to make assumptions related to customer purchase levels and redemption rates based on historical experience. If the redemption rate were to increase or decrease by 5%, it would result in a decrease or increase of approximately $1.8 million to operating profit.
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Pension. The obligations and related assets of the defined benefit retirement plan are presented in Note 10 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. Plan assets, which consist primarily of marketable equity and debt instruments, are valued using market quotations. Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions. Key assumptions in measuring the plan obligations include the discount rate and the estimated future return on plan assets. In determining the discount rate, we utilize the yield on fixed-income investments currently available with maturities corresponding to the anticipated timing of the benefit payments. Asset returns are based upon the anticipated average rate of earnings expected on the invested funds of the plans. At January 29, 2011, the weighted-average actuarial assumptions applied to our plan were a discount rate of 5.5% and long-term rate of return on plan assets of 7.0%. At January 30, 2010, the weighted-average actuarial assumptions applied to our plan were a discount rate of 5.8% and long-term rate of return on plan assets of 7.0%. To the extent actual results vary from assumptions, earnings would be impacted.
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Change in fair value of derivative instruments. In accordance with ASC 815, Derivatives and Hedging, the Company recognizes all derivatives on the balance sheet at fair value. For derivatives that are not designated as hedges under ASC 815, changes in the fair values are recognized in earnings in the period of change. The Company uses the Black-Scholes Pricing Model to calculate the fair value of derivative instruments. For fiscal years ended January 29, 2011 and January 30, 2010, the Company recorded a non-cash charge of $14.6 million and $16.8 million, respectively, related to the change in fair value of warrants. For fiscal years ended January 29, 2011 and January 30, 2010, the Company recorded a non-cash charge of $34.4 million and $49.7 million, respectively, related to the change in the fair value of the conversion feature of the PIES. At January 29, 2011, if the estimated discount rate were to have increased by 1%, the effect on the fair value of the warrants would have been approximately $0.1 million and the effect on the fair value of the conversion feature of the PIES would have been approximately $0.6 million.
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Income taxes. We 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 in which we do business. 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. During fiscal 2010, a decrease in the valuation reserve of $2.4 million for deferred tax assets was recorded. During fiscal 2009, an increase in the valuation reserve of $41.1 million for deferred tax assets was recorded.
Following the completion of the DSW IPO in June 2005, DSW is no longer included in Retail Ventures’ consolidated federal tax return. Following the disposition of an 81% ownership interest in the Value City operations during January 2008, Value City is no longer included in Retail Ventures’ consolidated federal tax return. Following the disposition of Filene’s Basement operations during April 2009, Filene’s Basement is no longer included in Retail Ventures’ consolidated federal tax return.
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Sale of subsidiary stock. Sales of stock by a subsidiary are accounted for by Retail Ventures as capital transactions.
RESULTS OF OPERATIONS
We have two business segments, DSW and Corporate. Our DSW segment is a specialty branded footwear retailer. As of January 29, 2011, a total of 311 DSW stores were open. The Corporate segment consists of all corporate assets, liabilities and expenses not allocated to the DSW segment through corporate allocation or shared service arrangements. As a result of RVI’s disposition of Filene’s Basement during fiscal 2009, the results of the Filene’s Basement operations are included in discontinued operations. As a result of RVI’s disposition of an 81% ownership interest in its Value City operations during fiscal 2007, the results of the Value City operations are also included in discontinued operations.
Seasonality
DSW’s business is subject to seasonal merchandise trends when its customers’ interest in new seasonal styles increases. Spring styles are new in the first quarter, and fall styles are new in the third quarter. Unlike many other retailers, DSW has not historically experienced a significantly large increase in net sales during its fourth quarter associated with the winter holiday season.
Fiscal Year
We follow a 52/53-week fiscal year that ends on the Saturday nearest to January 31. Fiscal years 2010, 2009 and 2008 each consisted of 52 weeks. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years.
The following table sets forth, for the periods indicated, the percentage relationships to net sales of the listed items included in our Consolidated Statements of Operations.
Fiscal Year Ended January 29, 2011 (“fiscal 2010”) Compared To Fiscal Year Ended January 30, 2010 (“fiscal 2009”)
Net Sales. DSW sales for fiscal 2010 increased by 13.7% from fiscal 2009. DSW comparable store sales increased 13.2% and 3.2% for fiscal 2010 and fiscal 2009, respectively. The following table summarizes the increase in net sales (in millions):
The increase in comparable store sales of 13.2% for fiscal 2010 was driven by an increase in transactions, as more customers visited DSW stores and dsw.com, and a higher percentage of those customers made purchases. All merchandise categories reported strong performance, with no single category driving the overall sales increase.
Gross Profit. Gross profit is defined as net sales less cost of sales. DSW gross profit increased $100.2 million, or 14.1%, from $712.1 million in fiscal 2009 to $812.3 million in fiscal 2010. Gross profit increased 20 basis points as a percentage of net sales in fiscal 2010 to 44.6% from 44.4% for fiscal 2009. Sales volume exceeded expectations during the spring season of fiscal 2010, which resulted in a reduction in markdown activity.
Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses decreased $42.8 million, or
6.2%, from $685.5 million in fiscal 2009 to $642.7 million in fiscal 2010. SG&A expenses, as a percentage of sales, decreased to 35.3% compared to 42.8% for the prior year’s period.
DSW segment SG&A expenses as a percentage of net sales were 35.0% and 38.6% for fiscal 2010 and fiscal 2009, respectively. DSW increased its marketing expenses to drive sales and have continued investing in its infrastructure resulting in additional depreciation expenses. Even with those increases, operating expenses for the year leveraged as a result of the sales increase compared to last year and a reduction in total store occupancy expense and overhead expenses driven by expense savings initiatives.
Corporate segment SG&A expense decreased $62.8 million in fiscal 2010 compared to fiscal 2009. The decrease in SG&A expense was primarily due to a reduction of bad debt expense of $2.7 million during the first quarter of fiscal 2010 due to an initial distribution from the debtors’ estates, compared to an increase in bad debt expense of $57.3 million during the first quarter of fiscal 2009 recorded against the notes and accounts receivable from Filene’s Basement due to the bankruptcy filing of Filene’s Basement on May 4, 2009. This was partially offset by the $4.0 million accrued for the complaint filed by Value City Holdings, Inc., Value City Department Stores LLC, Value City Department Stores Services, Inc., Value City of Michigan, Inc., Gramex Retail Stores, Inc., GB Retailers, Inc., J.S. Overland Delivery, Inc., Retail Ventures Jewelry, Inc., and VCHI Acquisition Co. (collectively, “Debtors”).
Change in Fair Value of Derivatives. During fiscal 2010 and 2009, the Company recorded a non-cash charge of $14.6 million and $16.8 million, respectively representing the changes in fair value of outstanding warrants. During fiscal 2010 and 2009, the Company recorded a non-cash charge of $34.4 million and $49.7 million, respectively, representing the change in the fair value of the conversion feature of the PIES. The Company utilizes the Black-Scholes Pricing Model to estimate the fair value of the derivatives. The change in the fair value of the derivatives is primarily due to the increases in the RVI and DSW stock prices.
Operating Profit (Loss). The operating profit for fiscal 2010 was $120.6 million compared to operating loss of $39.8 million in fiscal 2009, an increase of $160.4 million. The operating profit as a percentage of sales was 6.6% in fiscal 2010 compared to operating loss as a percentage of sales of 2.5% in fiscal 2009.
The operating loss for the Corporate segment declined $80.3 million to $53.0 million in fiscal 2010 from $133.3 million in fiscal 2009, primarily due to the change in fair value of derivative instruments.
The operating profit for DSW was $173.6 million in fiscal 2010 compared to $93.5 million in fiscal 2009 and increased as a percentage of net sales to 9.5% in fiscal 2010 from 5.8% in fiscal 2009. The increase in operating profit as a percentage of net sales was primarily the result of an increase in gross profit and a decrease in operating expenses.
Interest Expense. Interest expense was $13.5 million and $13.6 million in fiscal 2010 and fiscal 2009, respectively. Interest expense included the amortization of the debt discount of $2.4 million and $2.2 million in fiscal 2010 and fiscal 2009, respectively.
Interest Income. During fiscal 2010, interest income increased $0.9 million to $3.2 million. The increase in interest income was primarily a result of the reversals of interest reserves related to uncertain tax positions which were released during fiscal 2010.
Non-operating Income (Expense), net. Non-operating income, net of non-operating expense, for fiscal 2010 resulted from a gain on the sale of a fully impaired auction rate security which was sold during fiscal 2010.
Non-operating expense, net, for fiscal 2009 resulted from other-than-temporary impairments related to DSW auction rate securities partially offset by realized gains related to the sale of preferred shares.
Income Taxes. Fiscal 2010 reflects a 53.6% effective tax rate as compared to a 22.5% fiscal 2009 effective rate. The 2010 and 2009 tax rates reflect the impact of a non-cash charge of $14.6 million and a non-cash charge of $16.8 million, respectively, for the change in fair value on the mark to market accounting for the warrants.
Income (Loss) from Continuing Operations. The income from continuing operations was $51.8 million in fiscal 2010 compared to loss from continuing operations of $65.6 million in fiscal 2009 and represents 2.8% versus 4.1% of net sales, respectively.
Income (Loss) from Discontinued Operations - Value City Department Stores. The $2.7 million and $9.5 million reduction in the loss from discontinued operations in fiscal 2010 and fiscal 2009, respectively, was primarily due to revaluation of guarantees due to the passage of time.
Income (Loss) from Discontinued Operations - Filene’s Basement. The $3.9 million increase in the gain from discontinued operations, net of tax - Filene’s Basement during fiscal 2010 is primarily due to an initial distribution from the debtor’s estates.
In fiscal 2009, the income from the Filene’s Basement of $50.4 million was comprised of two components; the gain on the disposition of Filene’s Basement of $81.9 million partially offset by the loss from Filene’s Basement operations of $31.5 million. The gain on the disposition of Filene’s Basement was due to the write-off of the investment in Filene’s Basement partially offset by the recording of guarantees, other expenses relating to the disposition of Filene’s Basement and income tax benefit of $2.9 million in the aggregate.
Noncontrolling interests. For fiscal 2010 and fiscal 2009, net income attributable to Retail Ventures was impacted by $40.7 million and $20.4 million, respectively, to reflect that portion of the income attributable to DSW minority shareholders.
Fiscal Year Ended January 30, 2010 (“fiscal 2009”) Compared To Fiscal Year Ended January 31, 2009 (“fiscal 2008”)
Net Sales. DSW sales for fiscal 2009 increased by 9.5% to $1.60 billion from $1.46 billion for fiscal 2008. DSW comparable store sales increased 3.2% and decreased 5.9% for fiscal 2009 and fiscal 2008, respectively. The increase in net sales included a net increase of 6.6% from new and closed locations and dsw.com. The following table summarizes the increase in net sales (in millions):
The increase in comparable store sales of 3.2% for fiscal 2009 was primarily a result of an increase in traffic and average unit retail. DSW segment comparable sales increased in women’s footwear by 4.9%, athletic footwear by 1.8% and accessories by 12.6% and decreased in men’s footwear by 3.8%.
Gross Profit. Gross profit is defined as net sales less cost of sales. DSW gross profit increased $90.7 million, or 14.6%, from $621.4 million to $712.1 million. Gross profit increased 190 basis points as a percentage of net sales in fiscal 2009 to 44.4% from 42.5% for fiscal 2008 as the result of a decrease in markdown activity.
Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses increased $107.0 million, or 18.5%, from $578.5 million in fiscal 2008 to $685.5 million in fiscal 2009. SG&A expenses, as a percentage of sales, increased to 42.8% compared to 39.5% for the prior year’s period.
The increase in bonus expense of 110 basis points, marketing expense of 60 basis points and depreciation expense of 40 basis points was partially offset by decreases in store expenses of 60 basis points, new store expenses of 30 basis points, overhead expenses and other operating expenses as a percentage of net sales. Bonus expense increased due to improved operating results. New store expenses decreased due to DSW opening 32 fewer stores in fiscal 2009 compared to fiscal 2008. In addition, store occupancy expense as a percentage of net sales decreased to 12.9% for fiscal 2009 from 14.1% for fiscal 2008 as a result of increased average store sales, a reduction in store impairments and disposals of property and equipment and rent concessions from landlords.
Corporate segment SG&A expense increased $66.8 million in fiscal 2009. The increase in SG&A expense was primarily due to the bad debt charges of $57.3 million recorded for the notes and accounts receivable from liquidating Filene’s Basement due to the bankruptcy filing of Filene’s Basement on May 4, 2009. In addition, the increase in SG&A expense was due to expenses not being allocated to Filene’s Basement after the date of sale in April 2009.
Change in Fair Value of Derivatives. During fiscal 2009 the Company recorded a non-cash charge of $16.8 million and during fiscal 2008 recorded a non-cash reduction of expense of $35.9 million representing the changes in fair value of outstanding warrants. During fiscal 2009, the Company recorded a non-cash charge of $49.7 million and during fiscal 2008 recorded a non-cash reduction of expense of $49.3 million representing the change in the fair value of the conversion feature of the PIES. The Company utilizes the Black-Scholes Pricing Model to estimate the fair value of the derivatives. The change in the fair value of the derivatives is primarily due to the increases in the RVI and DSW stock prices.
Operating (Loss) Profit. The operating loss for fiscal 2009 was $39.9 million compared to operating profit of $128.0 million in fiscal 2008, a decrease of $167.9 million. The operating loss as a percentage of sales was 2.5% in fiscal 2009 compared to operating profit as a percentage of sales of 8.8% in fiscal 2008.
The operating loss for the Corporate segment declined $218.5 million to an operating loss of $133.3 million in fiscal 2009 from an operating profit of $85.2 million in fiscal 2008, primarily due to the bad debt charges recorded on the notes and accounts receivable from liquidating Filene’s Basement and the change in fair value of derivative instruments.
The operating profit for DSW was $93.5 million in fiscal 2009 compared to $42.8 million in fiscal 2008 and increased as a percentage of net sales to 5.8% in fiscal 2008 from 2.9% in fiscal 2008. The increase in operating profit as a percentage of net sales was primarily the result of an increase in gross profit partially offset by an increase in operating expenses.
Interest Expense. Interest expense was $13.6 million in both fiscal 2009 and fiscal 2008. Interest expense included the amortization of the debt discount of $2.2 million and $2.0 million in fiscal 2009 and fiscal 2008, respectively.
Interest Income. During fiscal 2009, interest income decreased $9.0 million to $2.3 million. The decrease was primarily attributable to the absence of interest income from the notes receivable from Filene’s Basement during fiscal year 2009. In addition, while cash and short-term investments increased compared to fiscal 2008, the increase was offset by a decrease in interest rates.
Non-operating (Expense) Income, Net. Non-operating expense, net, for fiscal 2009 represents other-than-temporary impairments on DSW’s auction rate securities net of realized gains related to the sale of preferred shares, which were the underlying assets of two auction rate securities. Non-operating income, net, for fiscal 2008 consists of a $1.5 million gain related to the repurchase of 200,000 units of PIES, partially offset by other-than-temporary impairments of DSW’s auction rate securities.
Income Taxes. Fiscal 2009 reflects a 22.5% effective tax rate as compared to a 13.4% fiscal 2008 effective rate. The 2009 and 2008 tax rates reflect the impact of a non-cash charge of $16.8 million and a non-cash reduction of expense of $35.9 million, respectively, for the change in fair value on the mark to market accounting for the warrants.
(Loss) Income from Continuing Operations. The loss from continuing operations was $65.6 million in fiscal 2009 compared to income from continuing operations of $109.2 million in fiscal 2008 and represents 4.1% versus 7.5% of net sales, respectively. Major contributing elements to this decrease are the $66.5 million decrease in the income from the change in the fair value of derivatives and the $9.0 million decrease in interest income.
Income (Loss) from Discontinued Operations - Value City Department Stores. The $9.5 million reduction in the loss from discontinued operations in fiscal 2009 was primarily due to revaluation of guarantees due to the passage of time.
Income (Loss) from Discontinued Operations - Filene’s Basement. The income from the Filene’s Basement of $50.4 million was comprised of two components; the gain on the disposition of Filene’s Basement of $81.9 million partially offset by the loss from Filene’s Basement operations of $31.5 million. The gain on the disposition of Filene’s Basement was due to the write-off of the investment in Filene’s Basement partially offset by the recording of guarantees, other expenses relating to the disposition of Filene’s Basement and income tax benefit of $2.9 million in the aggregate.
Noncontrolling interests. Fiscal 2009 net income decreased $20.4 million compared to $10.0 million in fiscal 2008, to reflect that portion of the income attributable to DSW minority shareholders.
Inflation and Deflation
Our results of our operations and financial condition are generally presented based upon historical cost. While it is difficult to accurately measure the impact of inflation or deflation because of the nature of the estimates required, management believes that the effect of inflation or deflation, if any, on our results of operations and financial condition has been minor; however, there can be no assurance that the business will not be affected by inflation or deflation in the future.
Liquidity and Capital Resources
Retail Ventures, Inc. relies on the cash flow of our subsidiaries, the Credit Facility and our cash on hand to meet our obligations, including our obligations under the PIES and under the Credit Facility, and the guarantees of certain obligations of Filene’s Basement and Value City. The ability of our subsidiaries to provide cash to Retail Ventures by way of dividends, distributions, interest or other payments (including intercompany loans) is subject to various restrictions, including restrictions imposed by the existing Credit Facility governing our subsidiaries’ indebtedness. Future indebtedness incurred by our subsidiaries may also limit or prohibit such payments. In addition, the ability of our subsidiaries to make such payments may be limited by relevant provisions of the laws of their respective jurisdictions of organization.
To the extent cash on hand and the Credit Facility are not sufficient to meet our operating cash flow needs we may seek other sources to provide the funds necessary for operations. Even though we could receive cash from DSW in the form of dividends, loans or otherwise, DSW has indicated that it does not currently plan to pay dividends in fiscal 2011 and RVI does not have a current arrangement for loans or other funding with DSW. DSW is a separate and distinct legal entity and currently has no obligation, contingent or otherwise, to distribute cash to us or to make funds available to service our coupon payments under the PIES.
Retail Ventures is continuing to review its available options to the extent it may become necessary to manage and enhance its liquidity position. Although RVI’s plan to enhance liquidity could include, among other things, the sale or collateralization of shares of common stock of DSW Inc. or a sale of equity by RVI, no assurance can be given that any such transaction can be completed on favorable terms or that such a transaction would satisfy all of RVI’s liquidity requirements. On January 15, 2010, Retail Ventures sold to DSW 320,000 Class B Common Shares, without par value, of DSW for an aggregate amount of $8.0 million. Proceeds from the sale were used for general corporate purposes and continuing expenses. In addition, on February 8, 2011, RVI entered into a Loan Agreement with SEI for a revolving credit facility of up to $30 million to provide for the ongoing working capital and general business needs of RVI for the term of the loan.
DSW’s primary ongoing cash requirements are for inventory purchases, capital expenditures in connection with expansion, improving information systems, the remodeling of existing stores and infrastructure growth. The primary sources of funds for these liquidity needs are cash flow from operations and credit facilities. For DSW, their working capital and inventory levels typically build seasonally. DSW believes that they have sufficient financial resources and access to financial resources at this time. DSW is committed to a cash management strategy that maintains liquidity to adequately support the operations of the business, its growth strategy and to withstand unanticipated business volatility. DSW believes that cash generated from DSW operations, together with its current levels of cash and equivalents and investments, as well as availability under its revolving credit facility, will be sufficient to maintain its ongoing operations, support seasonal working capital requirements and fund capital expenditures related to projected business growth for the foreseeable future.
Except as noted, the following discussion is based upon the consolidated liquidity position of RVI. See below under “Certain Liquidity Issues of RVI”.
Net working capital was $320.6 million and $369.2 million at January 29, 2011 and January 30, 2010, respectively. The decrease in net working capital was primarily related to the PIES being classified as a current liability at January 29, 2011, an increase in accounts payable primarily related to the inventory increase, accrued bonus related to improved operating results and accrued taxes related to the increase in earnings before income taxes. The decrease was partially offset by the increase in cash and short-term investments as a result of operating cash flow and a planned inventory increase. As of January 29, 2011 and January 30, 2010, the current ratio was 1.8 and 2.4, respectively.
Operating Activities
Net cash provided by operating activities from continuing operations totaled $127.0 million and $134.4 million in fiscal 2010 and fiscal 2009, respectively. Net income attributable to RVI, after adjusting for non-cash charges increased but was offset by income tax related items and the planned inventory increase net of the related increase in accounts payable.
Net cash provided by operating activities from continuing operations totaled $134.4 million and $94.0 million in fiscal 2009 and fiscal 2008, respectively. The fiscal 2009 increase of $40.4 million in net cash provided by operating activities is primarily due to a $10.2 million increase in income from continuing operations, after adjusting for non-cash charges, and a $23.9 million increase in the change in working capital assets and liabilities.
Investing Activities
For fiscal 2010, cash used in investing activities from continuing operations was $176.1 million compared to $87.3 million for fiscal 2009. During fiscal year ended January 29, 2011, $302.4 million of cash was used to purchase available-for-sale and held-to-maturity securities while $173.0 million of cash was generated by the sale of available-for-sale and held-to-maturity securities. DSW has increased its investment in longer term investments to increase its return. None of the investments have terms longer than two years. During fiscal 2010, we made $52.3 million in capital expenditures. Of this incurred amount, we incurred $34.6 million related to stores, $8.4 million related to supply chain projects and warehouses and $9.3 million related to information technology and infrastructure
For fiscal 2009, cash used in investing activities from continuing operations was $87.3 million compared to $101.6 million for fiscal 2008. During fiscal 2009, $224.0 million of cash was used to purchase available-for-sale and held-to-maturity securities while $160.7 million of cash was generated by the sale of available-for-sale and held-to-maturity securities. During fiscal 2009, we made $21.8 million in capital expenditures. Of this incurred amount, we incurred $10.4 million related to stores, $5.7 million related to supply chain projects and warehouses and $5.7 million related to information technology and infrastructure.
DSW expects to spend approximately $70 million for capital expenditures in fiscal 2011. DSW’s future investments will depend primarily on the number of stores DSW opens and remodels, infrastructure and information technology programs that DSW undertakes and the timing of these expenditures. In fiscal 2010, DSW opened 9 new stores. DSW plans to open approximately 15 to 20 stores in fiscal 2011. During fiscal 2010, the average investment required to open a typical new DSW store was approximately $1.8 million, prior to construction and tenant allowances. Of this amount, gross inventory typically accounted for $0.6 million, fixtures and leasehold improvements typically accounted for $0.9 million and new store advertising and other new store expenses typically accounted for $0.3 million.
Financing Activities
During fiscal 2010, cash used in financing activities by continuing operations was $0.1 million compared to cash provided by financing activities of $0.4 million in fiscal 2009.
During fiscal 2009, cash provided by and used in financing activities by continuing operations was $0.4 million compared to $5.4 million in fiscal 2008. During fiscal 2008, the cash used in financing activities was primarily due to the $5.6 million cash used to repurchase a portion of the outstanding PIES.
At the end of 2010, the RVI is not subject to any financial covenants; however, the DSW Revolving Loan and PIES contain numerous restrictive covenants relating to the Company’s management and operation. These non-financial covenants include, among other restrictions, limitations on indebtedness, guarantees, mergers, acquisitions, fundamental corporate changes, financial reporting requirements, budget approval, disposition of assets, investments, loans and advances, liens, dividends, stock purchases, transactions with affiliates, issuance of securities and the payment of and modifications to debt instruments under these agreements.
$100 Million Secured Revolving Credit Facility - The DSW Revolving Loan
On June 30, 2010, DSW entered into a $100 million secured revolving credit facility (the “DSW Credit Facility”) with a term of four years that will expire on June 30, 2014. This facility replaced an existing $150 million secured revolving credit facility (the “Previous DSW Credit Facility”) that expired July 5, 2010. Under the DSW Credit Facility, DSW and its subsidiary, DSW Shoe Warehouse, Inc. (“DSWSW”), are co-borrowers, with all other subsidiaries listed as guarantors. The DSW Credit Facility may be increased by up to $75 million upon DSW’s request and approval by increasing lenders and subject to customary conditions. The DSW Credit Facility provides for swing loans of up to $10 million and the issuance of letters of credit up to $50 million. The DSW Credit Facility is secured by a lien on substantially all of DSW’s personal property assets and its subsidiaries with certain exclusions and may be used to provide funds for general corporate purposes, to refinance existing letters of credit outstanding under DSW’s previous credit arrangement, to provide for DSW’s ongoing working capital requirements, and to make permitted acquisitions. Revolving credit loans bear interest under the DSW Credit Facility at DSW’s option under: (A) a base rate option at a rate per annum equal to the highest of (i) the Federal Funds Open Rate (as defined in the DSW Credit Agreement), plus 0.5%, (ii) the Agent’s prime rate, and (iii) the Daily LIBOR Rate (as defined in the DSW Credit Agreement) plus 1.0%, plus in each instance an applicable margin based upon DSW’s revolving credit availability; or (B) a LIBOR option at rates equal to the one, two, three, or six month LIBOR rates, plus an applicable margin based upon DSW’s revolving credit availability. Swing loans bear interest under the base rate option. DSW’s right to obtain advances under the DSW Credit Facility is limited by a borrowing base. In addition, the DSW Credit Facility contains restrictive covenants relating to DSW’s management and the operation of DSW’s business. These covenants, among other things, limit or restrict DSW’s ability to grant liens on its assets, incur additional indebtedness, enter into transactions with affiliates, merge or consolidate with another entity, redeem its stock and limit cash dividends up to the aggregate amount of 50% of the previous year’s net income, not to exceed $50.0 million. Additional covenants limit payments for capital expenditures to $75.0 million in any fiscal year, and if DSW has direct borrowings greater than $25.0 million, its credit facility also requires that DSW maintain a fixed charge coverage ratio of not less than 1.1 to 1.0. DSW paid $46.7 million for capital expenditures in fiscal 2010. As of January 29, 2011, DSW was not required to calculate the fixed charge coverage ratio as DSW did not have direct borrowings greater than $25.0 million. DSW had availability under the DSW Credit Facility of $80.8 million, outstanding letters of credit of $19.2 million and DSW was in compliance with all covenants related to the Credit Facility.
$143,750,000 Premium Income Exchangeable SecuritiesSM (PIES)
On August 10, 2006, Retail Ventures announced the pricing of its 6.625% Mandatorily Exchangeable Notes due September 15, 2011, or PIES, in the aggregate principal amount of $125,000,000. The closing of the transaction took place on August 16, 2006. On September 15, 2006, Retail Ventures closed on the exercise by the sole underwriter of its entire option to purchase an additional aggregate principal amount of $18,750,000 of PIES.
The $143,750,000 PIES bear a coupon at an annual rate of 6.625% of the principal amount, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing on December 15, 2006 and ending on September 15, 2011. Except to the extent RVI exercises its cash settlement option, the PIES are mandatorily exchangeable, on the maturity date, into Class A Common Shares of DSW, no par value per share, which are issuable upon exchange of DSW Class B Common Shares, no par value per share, beneficially owned by RVI. On the maturity date, each holder of the PIES will receive a number of DSW Class A Common Shares per $50.00 principal amount of PIES equal to the “exchange ratio” described in the RVI prospectus filed with the SEC on August 11, 2006, or if RVI elects, the cash equivalent thereof or a combination of cash and DSW Class A Common Shares. The exchange ratio is equal to the number of DSW Class A Common Shares determined as follows: (i) if the applicable market value of DSW Class A Common Shares equals or exceeds $34.95, the exchange ratio will be 1.4306 shares; (ii) if the applicable market value of DSW Class A Common Shares is less than $34.95 but greater than $27.41, the exchange ratio will be between 1.4306 and 1.8242 shares; and (iii) if the applicable market value of DSW Class A Common Shares is less than or equal to $27.41, the exchange ratio will be 1.8242 shares, subject to adjustment as provided in the PIES. The maximum aggregate number of DSW Class A Common Shares deliverable upon exchange of the PIES is 5,244,575 DSW Class A Common Shares, subject to adjustment as provided in the PIES.
RVI used the net proceeds of the offering to repay intercompany obligations to Value City and for general corporate purposes, including the repayment of borrowings under a former credit facility guaranteed by RVI.
The embedded exchange feature of the PIES is accounted for as a derivative, which is recorded at fair value with changes in fair value in the statement of operations. Accordingly, the accounting for the embedded derivative addresses the variations in the fair value of the obligation to settle the PIES when the market value exceeds or is less than the threshold appreciation price. The fair value of the conversion feature at the date of issuance of $11.7 million was equal to the amount of the discount of the PIES and will be amortized into interest expense over the term of the PIES.
During fiscal 2010, the Company recorded a non-cash charge of $34.4 million related to the change in fair value of the conversion feature of the PIES. As of January 29, 2011, the fair value liability recorded for the conversion feature of the PIES was $6.4 million.
During fiscal 2009, the Company recorded a non-cash charge of $49.7 million related to the change in fair value of the conversion feature of the PIES. During fiscal 2008, the Company recorded a non-cash reduction of expense of $49.3 million related to the change in fair value of the conversion feature of the PIES. As of January 30, 2010, the fair value asset recorded for the conversion feature of the PIES was $28.0 million.
Warrants
The Company has outstanding warrants to purchase up to 1,952,498 RVI Common Shares (including 1,731,460 to Schottenstein RVI LLC, a related party) at an initial exercise price of $4.50 per share or up to 370,904 (including 328,915 to Schottenstein RVI LLC, a related party) DSW Class A Common Shares owned by Retail Ventures at an initial exercise price of $19.00 per share. The warrants are subject to certain anti-dilution provisions and are exercisable at any time on or prior to June 11, 2012. The Company has granted registration rights with respect to the shares issuable upon exercise of the warrants. Retail Ventures is subject to contractual obligations with its warrantholders to retain enough DSW Common Shares to be able to satisfy its obligations to deliver such shares to its warrantholders if the warrantholders elect to exercise their warrants in full for DSW Class A Common Shares.
For fiscal 2010, the Company recorded a non-cash charge of $14.6 million for the change in fair value of warrants, of which the portion held by related parties was a non-cash charge of $13.0 million.
For fiscal 2009, the Company recorded a non-cash charge of $16.8 million for the change in fair value of warrants, of which the portion held by related parties was a non-cash charge of $6.9 million. For fiscal 2008, the Company recorded a non-cash reduction of expense of $35.9 million for the change in fair value of warrants, of which the portion held by related parties was a non-cash reduction of expenses of $30.0 million.
Effective November 16, 2010, Retail Ventures, Inc. issued 1,214,572 of its common shares, without par value, to Cerberus Partners, L.P. (“Cerberus”) in connection with Cerberus’ exercise of its outstanding term warrant that was originally issued by the Company on July 5, 2005. The warrant was exercised on a cashless exercise basis as permitted by the warrant, resulting in the issuance of 1,214,572 of the 1,731,460 shares for which the warrant could have been exercised (at an exercise price of $4.50 per share). In connection with this issuance, no payment was made to RVI, no underwriters were utilized and no commissions were paid.
Liquidity and Capital Resources Considerations Relating to the Value City Disposition
RVI completed the disposition of an 81% ownership interest in its Value City business on January 23, 2008. Retail Ventures or its wholly-owned subsidiary, Retail Ventures Services, Inc. (“RVS”), guaranteed or may, in certain circumstances, be responsible for certain liabilities of Value City including, but not limited to: amounts owed under certain guarantees with various financing institutions for Value City inventory purchases made prior to the disposition date; amounts owed for guaranteed severance for certain Value City employees; amounts owed under lease obligations for certain equipment leases; amounts owed under certain employee benefit plans if the plans are not fully funded on a termination basis; amounts owed for certain workers compensation claims for events prior to the disposition date; amounts owed under certain income tax liabilities and the guarantee of other amounts.
As of January 29, 2011 and January 30, 2010, the amount of RVI’s guarantees of Value City commitments was $0.4 million and $2.9 million, respectively. The reduction in the liability through January 29, 2011 is due to payments by the primary obligor to the guaranteed party or information available indicating that it was no longer probable that the guaranteed liability would be incurred. On October 26, 2008, Value City filed for bankruptcy protection and announced that it would close its remaining stores. RVI may become subject to risks associated with the bankruptcy filing by Value City, if creditors whose obligations RVI has guaranteed are not paid.
To facilitate the change in ownership and operation of Value City, Retail Ventures agreed to provide or arrange for the provision of certain transition services to Value City for a period of one year unless otherwise extended by both parties. We have negotiated an agreement with Value City to continue to provide services post bankruptcy filing until the liquidation is complete, including risk management, financial services, benefits administration, payroll and information technology services, in exchange for a weekly payment. We have submitted a proof of claim in the bankruptcy proceeding seeking payment in full for all amounts owed to us. However, there is no assurance that we will be able to collect all or any of the amounts owed to us.
Liquidity and Capital Resources Considerations Relating to the Filene’s Basement Disposition
On April 21, 2009, we sold all of the outstanding capital stock of Filene’s Basement and certain related entities to FB II Acquisition Corp., a newly formed entity owned by Buxbaum Holdings, Inc. Retail Ventures guaranteed or may, in certain circumstances, be responsible for certain liabilities of Filene’s Basement, including, but not limited to, amounts owed under lease obligations related to leases not assumed by New Filene’s Basement. As of January 29, 2011, RVI has recorded a liability of $0.2 million for the guarantees of Filene’s Basement commitments, primarily for lease obligations. On May 4, 2009, liquidating Filene’s Basement filed for bankruptcy protection. On June 18, 2009, following bankruptcy court approval, Syms purchased certain assets of Filene’s Basement. The Company negotiated with Syms to provide transition services in exchange for payment.
On September 25, 2009, RVI and DSW entered into a settlement agreement with liquidating Filene’s Basement and its related debtors and the Official Committee of Unsecured Creditors appointed in the Chapter 11 case for the debtors. On November 3, 2009, the settlement agreement was approved by the Bankruptcy Court for the District of Delaware. Effective as of the court’s approval, under the settlement agreement, RVI’s claims in respect of $52.6 million in notes receivable from liquidating Filene’s Basement were released; RVI assumed the rights and obligations related to (and agreed to indemnify liquidating Filene’s Basement with regard to certain matters arising out of) the liquidating Filene’s Basement defined benefit pension plan; and liquidating Filene’s Basement and the creditors’ committee agreed to allow certain general unsecured claims for amounts owed to RVI and DSW. The parties also agreed to certain provisions affecting the proper allocation of proceeds paid to RVI or liquidating Filene’s Basement in connection with specified third party litigation and to certain provisions related to the debtors’ recovery from third parties that are the beneficiaries of letters of credit or hold collateral related to workers’ compensation claims. The settlement agreement also provides for certain mutual releases among the debtors, the creditors’ committee, RVI, DSW and other parties. (The foregoing description of the Settlement Agreement is qualified in its entirety by reference to the terms of the settlement agreement, which is filed herewith as Exhibit 10.101 and incorporated herein by reference.)
Although the settlement agreement provides that RVI and DSW will have certain allowed claims against liquidating Filene’s Basement and its related debtors, there can be no assurance as to whether RVI or DSW will ultimately recover any additional amounts from the debtors in connection with these claims. A plan of reorganization of the debtors was confirmed by the court on January 26, 2010, and an initial distribution from the debtors’ estates of $7.3 million to RVI and $0.3 million to DSW has been made. However, there can be no assurance as to timing or the amount of any distribution in respect of RVI’s or DSW’s claims (or whether RVI or DSW will recover any of the remainder of the amounts in connection with their claims). Failure to recover such amounts may negatively affect liquidity at RVI. In addition, as a result of the releases provided by the settlement agreement, RVI and DSW have relinquished the right to pursue additional claims, which may include unknown or unmatured claims, against the debtors. By assuming the liquidating Filene’s Basement defined benefit pension plan, RVI has become responsible for maintaining this plan, and any contributions required to be made by RVI could negatively affect liquidity at RVI.
Certain Liquidity Issues of RVI
Retail Ventures is a holding company and all our operations are conducted through our subsidiaries. RVI has no net sales on a standalone basis. Therefore, we rely on the cash flow of our subsidiaries, the Credit Facility and our cash on hand to meet our obligations, including our obligations under the PIES and the Credit Facility, and the guarantees of certain obligations of Filene’s Basement and Value City. The ability of our subsidiaries to provide cash to Retail Ventures by way of dividends, distributions, interest or other payments (including intercompany loans) is subject to various restrictions, including restrictions imposed by the existing Credit Facility governing our subsidiaries’ indebtedness. Future indebtedness incurred by our subsidiaries may also limit or prohibit such payments. In addition, the ability of our subsidiaries to make such payments may be limited by relevant provisions of the laws of their respective jurisdictions of organization.
To the extent cash on hand and the Credit Facility are not sufficient to meet our operating cash flow needs we may seek other sources to provide the funds necessary for operations. Even though we could receive cash from DSW in the form of dividends, loans or otherwise, DSW has indicated that it does not currently plan to pay dividends in fiscal 2011 and RVI does not have a current arrangement for loans or other funding with DSW. DSW is a separate and distinct legal entity and currently has no obligation, contingent or otherwise, to distribute cash to us or to make funds available to service our coupon payments under the PIES.
Retail Ventures is continuing to review its available options to the extent it may become necessary to manage and enhance its liquidity position in the event the Merger does not close. Although RVI’s plan to enhance liquidity could include, among other things, the sale or collateralization of shares of common stock of DSW Inc. or a sale of equity by RVI, no assurance can be given that any such transaction can be completed on favorable terms or that such a transaction would satisfy all of RVI’s liquidity requirements. On January 15, 2010, Retail Ventures sold to DSW 320,000 Class B Common Shares, without par value, for an aggregate amount of $8.0 million. Proceeds from the sale were used for general corporate purposes and continuing expenses. In addition, on February 8, 2011, RVI entered into a Loan Agreement with SEI for a revolving credit facility of up to $30 million to provide for the ongoing working capital and general business needs of RVI for the term of the loan. All outstanding principal and accrued but unpaid interest under the Credit Facility is due and payable in full on the earlier of either February 8, 2013 or two days after the closing of the Merger.
Contractual Obligations
We have the following minimum commitments under contractual obligations. A “purchase obligation” is defined as an agreement to purchase goods or services that is enforceable and legally binding on us and that specifies all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions and the approximate timing of the transaction. Other long-term liabilities are defined as long-term liabilities that are reflected on the balance sheet in accordance with GAAP. Based on this definition, the table below includes only those contracts which include fixed or minimum obligations. It does not include normal purchases, which are made in the ordinary course of business.
The following table provides aggregated information about known contractual obligations and other long-term liabilities as of January 29, 2011 (in thousands):
(1)
Projected interest payments are for the PIES are based on the outstanding principal amount at January 29, 2011 and interest rate per the agreement.
(2)
Many of our operating leases require us to pay contingent rent based on sales, common area maintenance and real estate taxes. Contingent rent, costs and taxes vary year by year and are based almost entirely on actual costs incurred. As such, they are not included in the lease obligations presented above. Other non current liabilities of $104.1 million are primarily comprised of deferred rent liabilities, construction and tenant allowances, and uncertain tax positions. Deferred rent, which is included in other non current liabilities, is excluded from this table as our payment obligations are included in the operating lease obligations. Construction and tenant allowances, which are included in other non current liabilities, are not contractual obligations as the balance represents cash allowances from landlords, which are deferred and amortized on a straight-line basis over the non-cancellable terms of the lease.
(3)
Construction commitments include capital items to be purchased for projects that were under construction, or for which a lease had been signed, as of January 29, 2011.
(4)
Many of our purchase obligations are cancelable by us without payment or penalty, and we have excluded such obligations.
(5)
Pension is included in the “More Than 5 Years” column as we are not able to reasonably estimate the timing of the potential future payments.
(6)
Other contractual obligations include purchase commitments, guarantees and indemnifications. Many of our purchase commitments are cancelable by us without payment or penalty, and we have excluded such commitments, along with all associate employment and intercompany commitments.
(7)
The amount of obligations related to uncertain tax positions as of January 29, 2011, is $3.2 million, including approximately $0.3 million of accrued interest and penalties. Uncertain tax benefits are positions taken or expected to be taken on an income tax return that may result in additional payments to tax authorities. We may not be required to settle these obligations. Uncertain tax positions are included in the “More Than 5 Years” column as we are not able to reasonably estimate the timing of the potential future payments.
(8)
Deferred taxes and noncontrolling interest are not included in this table.
At January 29, 2011 and January 30, 2010, the Company has $133.8 million of PIES outstanding.
DSW had outstanding letters of credit on the DSW Revolving Loan of $19.2 million and $17.4 million at January 29, 2011 and January 30, 2010 respectively. If certain conditions are met under these letter of credit arrangements, DSW 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 payment outside of the terms set forth in these arrangements.
As of January 29, 2011, DSW 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. DSW’s obligations under these commitments aggregated to approximately $3.4 million as of January 29, 2011. In addition, as of January 29, 2011, DSW has signed nine lease agreements for new store locations opening in fiscal 2011 and 2012 with total annual rent of approximately $5.6 million. In connection with the new lease agreements, DSW expects to receive a total of approximately $5.3 million of construction and tenant allowances, which reimburses DSW for expenditures at these locations.
We operate all DSW stores, warehouses and corporate office space from leased facilities. Lease obligations are accounted for either as operating leases or as capital leases. As of January 29, 2011, the Company had no capital leases. See Note 6 to Consolidated Financial Statements for the minimum payments due under operating or capital leases.
Additional information regarding our financial commitments as of January 29, 2011 is provided in Notes 7 and 13 to Consolidated Financial Statements.
Recent Accounting Pronouncements
Recent accounting pronouncements and their impact on Retail Ventures are disclosed in Note 1 of our Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.
Off-Balance Sheet Arrangements
It is not our intention 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. Retail Ventures had no “off-balance sheet” arrangements as of January 29, 2011, as that term is described by the SEC.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to market risk from changes in interest rates, which may adversely affect our financial position, results of operations and cash flows. In seeking to minimize the risks from interest rate fluctuations, we manage exposures through our regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We do not use financial instruments for trading or other speculative purposes and are not party to any leveraged financial instruments.
Investments
Our cash and equivalents have maturities of 90 days or fewer. At times, cash and equivalents may be in excess of Federal Deposit Insurance Corporation (“FDIC”) insurance limits. DSW also has investments in various short-term and long-term investments. DSW’s available-for-sale investments generally renew every 7 days and DSW also has held-to-maturity investments that have terms greater than 365 days. These financial instruments may be subject to interest rate risk through lost income should interest rates increase during their term to maturity and thus may limit DSW’s ability to invest in higher income investments.
Secured Revolving Credit Facilities
DSW is exposed to interest rate risk primarily through its borrowings under the $100 million DSW Credit Facility. At January 29, 2011, DSW had no direct borrowings under its credit facility and had $19.2 million of letters of credit outstanding. DSW’s future borrowings, if any, would bear interest at rates in accordance with its credit facility and would be subject to interest rate risk. Because DSW has no outstanding debt, DSW does not believe that a hypothetical adverse change of 1% in interest rates would have a material effect on its financial position.
Warrants
For derivatives that are not designated as hedges under ASC 815, Derivatives and Hedging, changes in the fair values are recognized in earnings in the period of change. Retail Ventures estimates the fair value of derivatives based on pricing models using current market rates and records all derivatives on the balance sheet at fair value.
As of January 29, 2011, the Company had 1,952,498 warrants outstanding. All previously outstanding unexercised warrants expired.
During fiscal 2010, the Company recorded a non-cash charge related to the change in the fair value of the warrants of $14.6 million. As of January 29, 2011, the aggregate fair value liability recorded relating to the warrants is $20.6 million. The fair value liability was estimated as of January 29, 2011 using the Black-Scholes Pricing Model with the following assumptions: risk-free interest rate of 0.5%; expected life of 1.4 years; expected volatility of 49.4% and an expected dividend yield of 0.0%. As the warrants may be exercised for either Common Shares of RVI or Common Shares of DSW owned by RVI, the settlement of such warrants will not result in a cash outlay by the Company. At January 29, 2011, if the estimated discount rate were to have increased by 1%, the effect on the fair value of the warrants would have been approximately $0.1 million.
Conversion Feature of PIES
During fiscal 2010, the Company recorded a non-cash charge related to the change in fair value of the conversion feature of the PIES of $34.4 million. As of January 29, 2011, the fair value liability recorded for the conversion feature was $6.4 million. The fair value was estimated as of January 29, 2011 using the Black-Scholes Pricing Model with the following assumptions: risk-free interest rate of 0.9%; expected life of 0.6 years; expected volatility of 46.8%; and an expected dividend yield of 0.0%. The fair value of the conversion feature at the date of issuance of $11.7 million is equal to the amount of the discount of the PIES and will be amortized into interest expense over the term of the PIES. At January 29, 2011, if the estimated discount rate were to have increased by 1%, the effect on the fair value of the conversion feature of the PIES would have been approximately $0.6 million.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Our financial statements and the Report of Independent Registered Public Accounting Firm thereon are filed pursuant to this Item 8 and are included in this Annual Report on Form 10-K beginning on page.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES.
The Company, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, performed an evaluation of the Company’s disclosure controls and procedures, as designed by Securities Exchange Act rules 13a-15(e) and 15d-15(e). Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded, as of January 29, 2011, that such disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America.
Internal control systems, no matter how well designed and operated, have inherent limitations, including the possibility of the circumvention or overriding of controls. Due to these inherent limitations, the Company’s internal control over financial reporting may not prevent or detect misstatements. As a result, projections of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control system as of January 29, 2011. In making its assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on this assessment, management concluded that the Company maintained effective internal control over financial reporting as of January 29, 2011.
Deloitte & Touche LLP, the Company’s independent registered public accounting firm, has issued an audit report covering the Company’s internal control over financial reporting, as stated in its report which begins on page of this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
No change was made in the Company’s internal control over financial reporting during the Company’s fiscal quarter ended January 29, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
In accordance with General Instruction G(3), the information contained under the captions “EXECUTIVE OFFICERS”, ELECTION OF DIRECTORS” and “OTHER DIRECTOR INFORMATION, COMMITTEES OF DIRECTORS AND CORPORATE GOVERNANCE INFORMATION” in our definitive Proxy Statement for the 2011 Annual Meeting of Shareholders to be filed with the SEC pursuant to Regulation 14A promulgated under the Exchange Act (the “Proxy Statement”), are incorporated herein by reference to satisfy the information required by this Item.
In accordance with General Instruction G(3), the information contained under the captions “COMPENSATION OF MANAGEMENT” and “OTHER DIRECTOR INFORMATION COMMITTEES OF DIRECTORS AND CORPORATE GOVERNANCE INFORMATION - GENERAL” in the Proxy Statement is incorporated herein by reference to satisfy the information required by this Item. The report of the Compensation Committee of the Company’s Board of Directors on executive compensation included in the Proxy Statement shall not be deemed to be incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS.
In accordance with General Instruction G(3), the information contained under the captions “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS” and “EQUITY COMPENSATION PLAN INFORMATION” in the Proxy Statement is incorporated herein by reference to satisfy the information required by this Item.
EQUITY COMPENSATION PLAN TABLE
The following table sets forth certain information as of January 29, 2011 about the Company’s existing equity compensation plans and arrangements. The information includes the number of Common Shares covered by, and the weighted average exercise price of, outstanding options, warrants and other rights and the number of Common Shares remaining available for future grants, excluding the Common Shares to be issued upon exercise of outstanding options, warrants and other rights.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
In accordance with General Instruction G(3), the information contained under the caption “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” and “OTHER DIRECTOR INFORMATION, COMMITTEES OF DIRECTORS AND CORPORATE GOVERNANCE INFORMATION - CORPORATE GOVERNANCE PRINCIPLES” in the Proxy Statement is incorporated herein by reference to satisfy the information required by this Item.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES.
In accordance with General Instruction G(3), the information contained under the caption “AUDIT AND OTHER SERVICE FEES” in the definitive Proxy Statement is incorporated herein by reference to satisfy the information required by this Item.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
Schedules not filed are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements or the notes thereto.
15(a)(3) and (b) Exhibits:
15(c) Additional Financial Statement Schedules:
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
*By:
/s/ James A. McGrady
James A. McGrady (Attorney-in-fact)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Retail Ventures, Inc.
Columbus, Ohio
We have audited the accompanying consolidated balance sheets of Retail Ventures, Inc. and subsidiaries (the ‘Company’) as of January 29, 2011 and January 30, 2010, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended January 29, 2011. Our audits also included the financial statement schedule listed in the index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Retail Ventures, Inc. and subsidiaries as of January 29, 2011 and January 30, 2010, and the results of their operations and their cash flows for each of the three years in the period ended January 29, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As disclosed in Note 1 to the consolidated financial statements, the consolidated financial statements have been adjusted for the retrospective application of the new accounting guidance on accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) and noncontrolling interests in consolidated financial statements, which became effective February 1, 2009.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of January 29, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 28, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
Columbus, Ohio
March 28, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Retail Ventures, Inc.
Columbus, Ohio
We have audited the internal control over financial reporting of Retail Ventures, Inc. and subsidiaries (the “Company”) as of January 29, 2011 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 29, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended January 29, 2011 of the Company and our report dated March 28, 2011 expressed an unqualified opinion on those financial statements and financial statement schedule and included an explanatory paragraph relating to the retrospective application of the new accounting guidance on accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) and new accounting guidance on accounting for noncontrolling interests in consolidated financial statements, which became effective February 1, 2009.
/s/ Deloitte & Touche LLP
Columbus, Ohio
March 28, 2011
RETAIL VENTURES, INC.
CONSOLIDATED BALANCE SHEETS
January 29, 2011 and January 30, 2010
(in thousands, except share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC
CONSOLIDATED BALANCE SHEETS (Continued)
January 29, 2011 and January 30, 2010
(in thousands, except share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands, except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands, except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Continued)
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Continued)
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
RETAIL VENTURES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Operations
Retail Ventures, Inc. (“Retail Ventures” or “RVI”) and its wholly-owned subsidiaries and majority-owned subsidiary are herein referred to collectively as the “Company”. Retail Ventures’ Common Shares are listed on the New York Stock Exchange under the ticker symbol “RVI”. The Company operates two segments in the United States of America (“United States”) as of January 29, 2011. DSW Inc. (“DSW”) is a specialty branded footwear retailer. The Corporate segment consists of all revenue and expenses that are not allocated to the DSW segment. As of January 29, 2011, there were 311 DSW stores located throughout the United States. DSW also supplies shoes, under supply arrangements, for 352 locations for four retailers in the United States.
On July 5, 2005, DSW completed an initial public offering (“IPO”) of 16,171,875 Class A Common Shares sold at a price of $19.00 per share and raising net proceeds of $285.8 million, net of the underwriters’ commission and before expenses of approximately $7.8 million. As of January 29, 2011, Retail Ventures owned Class B Common Shares of DSW representing approximately 62.0% of DSW’s outstanding Common Shares, including DSW director stock units, and approximately 92.9% of the combined voting power of such shares. RVI accounted for the sale of DSW as a capital transaction. Associated with this transaction, a deferred tax liability of $65.5 million was recorded. DSW is a controlled subsidiary of Retail Ventures and its Class A Common Shares are listed on the New York Stock Exchange under the ticker symbol “DSW”.
On January 23, 2008, Retail Ventures disposed of an 81% ownership interest in its Value City Department Stores (“Value City”) business to VCHI Acquisition Co., a newly formed entity owned by VCDS Acquisition Holdings, LLC, Emerald Capital Management LLC and Crystal Value, LLC. Retail Ventures received no net cash proceeds from the sale, paid a fee of $0.5 million to the purchaser, and recognized an after-tax loss of $64.5 million on the transaction as of January 29, 2011. As part of the transaction, Retail Ventures, Inc. issued warrants to VCHI Acquisition Co. to purchase 150,000 RVI Common Shares, at an exercise price of $10.00 per share, and exercisable within 18 months of January 23, 2008. The warrants expired in June 2009. To facilitate the change in ownership and operation of Value City Department Stores, Retail Ventures agreed to provide or arrange for the provision of certain transition services principally related to information technology, finance and human resources to Value City Department Stores for a period of one year unless otherwise extended by both parties. On October 26, 2008, Value City filed for bankruptcy protection and announced that it would close its remaining stores. The Company negotiated an agreement with Value City to continue to provide services post bankruptcy filing, including risk management, financial services, benefits administration, payroll and information technology services, in exchange for a weekly payment. As of January 29, 2011, the Company is no longer providing services to Value City. On October 25, 2010, Value City Holdings, Inc., Value City Department Stores LLC, Value City Department Stores Services, Inc., Value City of Michigan, Inc., Gramex Retail Stores, Inc., GB Retailers, Inc., J.S. Overland Delivery, Inc., Retail Ventures Jewelry, Inc., and VCHI Acquisition Co. filed a complaint against RVI, Retail Ventures Services, Inc., and DSW in the United States Bankruptcy Court for the Southern District of New York. The complaint relates to the debtors’ pending voluntary cases under Chapter 11 of the Bankruptcy Code.
In the complaint, the debtors alleged claims for avoidable preferences, fraudulent transfer, receipt of illegal dividends, recovery of assets, unjust enrichment and breach of contract. The claims primarily related to transfers made by the debtors to the defendants during the one year period preceding the debtors’ filing of voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code on October 26, 2008. The debtors sought damages that totaled approximately $373.4 million.
On January 20, 2011, the Bankruptcy Court approved a settlement between the debtors and the defendants, which became final and non-appealable as of February 4, 2011. The defendants have paid to Value City the settlement payment of $3.6 million and Value City has filed a dismissal of the complaint.
On April 21, 2009, Retail Ventures disposed of Filene’s Basement, Inc. and certain related entities to FB II Acquisition Corp., a newly formed entity owned by Buxbaum Holdings, Inc. (“Buxbaum”). Retail Ventures did not realize any cash proceeds from this transaction, agreed to pay a fee of $1.3 million to Buxbaum, which has been paid, and has reimbursed $0.4 million of Buxbaum’s costs associated with the transaction. Retail Ventures has also agreed to indemnify Buxbaum, FB II Acquisition Corp. and their owners against certain liabilities. Retail Ventures has recognized an after-tax gain of $85.8 million on the transaction as of January 29, 2011. On May 4, 2009, Filene’s Basement filed for bankruptcy protection. On June 18, 2009, following bankruptcy court approval, SYL LLC, a subsidiary of Syms Corp (“Syms”), purchased certain assets of Filene’s Basement. All references to “liquidating Filene’s Basement” refer to the debtor, formerly known as Filene’s Basement Inc., and its debtor subsidiaries remaining after the asset purchase by a subsidiary of Syms. All references to “New Filene’s Basement” refer to the stores operated by Syms. The Company negotiated with Syms to provide transition services in exchange for payment. As of January 29, 2011, the Company is no longer providing transition services to Syms. On September 25, 2009, RVI and DSW entered into a settlement agreement with liquidating
Filene’s Basement and its related debtors and the Official Committee of Unsecured Creditors appointed in the Chapter 11 case for the debtors. On November 3, 2009, the settlement agreement was approved by the Bankruptcy Court for the District of Delaware. As a result of the court’s approval of the settlement agreement, RVI’s claims in respect of $52.6 million in notes receivable from liquidating Filene’s Basement were released; RVI assumed the rights and obligations related to (and agreed to indemnify liquidating Filene’s Basement with regard to certain matters arising out of) the liquidating Filene’s Basement defined benefit pension plan; and liquidating Filene’s Basement and the creditors’ committee agreed to allow certain general unsecured claims for amounts owed to RVI and DSW. The parties also agreed to certain provisions affecting the proper allocation of proceeds paid to RVI or liquidating Filene’s Basement in connection with specified third party litigation and to certain provisions related to the debtors’ recovery from third parties that are the beneficiaries of letters of credit or hold collateral related to workers’ compensation claims. The settlement agreement also provides for certain mutual releases among the debtors, the creditors’ committee, RVI, DSW and other parties. Although the settlement agreement provides that RVI will have certain allowed claims against the debtors, there can be no assurance as to whether RVI will ultimately recover all of the amounts in connection with these claims. A plan of reorganization of the debtors was confirmed by the court on January 26, 2010, and an initial distribution from the debtors’ estates of $7.3 million to RVI and $0.3 million to DSW has been made. However, there can be no assurance as to timing or the amount of any additional distribution in respect of its claims (or whether RVI will recover any of the remainder of the amounts in connection with its claims). In addition, as a result of the releases provided by the settlement agreement, RVI has relinquished the right to pursue additional claims, which may include unknown or unmatured claims, against the debtors.
Principles of Consolidation
The consolidated financial statements include the accounts of Retail Ventures, its wholly-owned subsidiaries and its majority-owned subsidiary. All intercompany accounts and transactions have been eliminated in consolidation. As a result of RVI’s disposition of Filene’s Basement during fiscal 2009, the results of Filene’s Basement operations are included in discontinued operations. As a result of RVI’s disposition of an 81% ownership interest in its Value City business during fiscal 2007, the results of the Value City operations are also included in discontinued operations. See Note 2 to the Consolidated Financial Statements for a discussion of discontinued operations.
Fiscal Year
The Company’s fiscal year ends on the Saturday nearest January 31. Fiscal 2010, 2009 and 2008 each consisted of 52 weeks. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Significant estimates are required as a part of determination of fair value of derivative instruments, inventory valuation, depreciation, amortization, recoverability of long-lived assets and intangible assets and establishing reserves for self-insurance. Although these estimates are based on management’s knowledge of current events and actions it may undertake in the future, actual results could differ from these estimates.
Financial Instruments
The following assumptions were used to estimate the fair value of each class of financial instruments:
Cash and Equivalents
Cash and equivalents represent cash, money market funds and highly liquid investments with original maturities of three months or fewer at the date of purchase and credit card receivables, which generally settle within three days. Amounts due from banks for credit card transactions totaled $11.1 million and $8.6 million at January 29, 2011 and January 30, 2010, respectively. The carrying amounts of cash and equivalents approximate fair value.
The Company reviews cash balances on a bank by bank basis to identify book overdrafts. Book overdrafts occur when the amount of outstanding checks exceed the cash deposited at a bank. The Company reclassifies book overdrafts, if any, to accounts payable.
Investments
Investments are classified as available-for-sale or held-to-maturity securities based on the Company’s intent. All income generated from these investments is recorded as interest income.
The Company evaluates its investments for impairment and whether impairment is other-than-temporary. In fiscal 2010 and 2009, the Company recognized realized gains of $1.5 million for the sale of a fully impaired auction rate security and $0.5 million related to the sale of preferred shares, respectively, as non-operating income. In fiscal 2009 the Company recognized other-than-temporary impairments of $2.9 million, excluding realized gains of $0.5 million, as non-operating expense. In fiscal 2008, the Company recognized other-than-temporary impairments of $1.1 million, as non-operating expense related to the impairment of auction rate securities. The Company did not recognize any impairment on investments during fiscal 2010 or gains in fiscal 2008. Please see Note 5 for additional discussion of the Company’s investments.
Accounts Receivable
Accounts receivable are classified as current assets because the average collection period is generally less than one year. The carrying amount approximates fair value because of the relatively short average maturity of the instruments and no significant change in interest rates.
Concentration of Credit Risk
Financial instruments, which principally subject the Company to concentration of credit risk, consist of cash and equivalents and investments. The Company invests excess cash when available through financial institutions in money market accounts and term investments. At times, such amounts may be in excess of Federal Deposit Insurance Corporation (“FDIC”) insurance limits and the Company mitigates the risks by utilizing multiple banks.
Concentration of Vendor Risk
During fiscal 2010, 2009 and 2008, merchandise supplied to the Company by three key vendors accounted for approximately 20%, 21% and 20% of net sales, respectively.
Allowance for Doubtful Accounts
The Company monitors its exposure for credit losses and records related allowances for doubtful accounts. Allowances are estimated based upon specific accounts receivable balances, where a risk of default has been identified. The reduction in fiscal 2010 is related to the reversal of allowances recorded for receivables from liquidating Filene’s Basement due to an initial distribution from the debtor’s estates and the reversal of the claim related to the Value City bankruptcy estate in December 2010. The following table summarizes the activity related to the Company’s allowance for doubtful accounts, excluding discontinued operations (in thousands):
In addition, during the quarter ended May 2, 2009, there was an allowance recorded for $52.6 million to fully reserve for the notes receivable from liquidating Filene’s Basement. Effective November 3, 2009, RVI’s claims against liquidating Filene’s Basement in respect of these notes receivables were released in connection with a Settlement Agreement approved by the bankruptcy court. The following table summarizes the activity related to the Company’s allowance for notes receivable from liquidating Filene’s Basement (in thousands):
Inventories
Merchandise inventories are stated at net realizable value, determined using the first-in, first-out basis, or market, using the retail inventory method. The retail 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 profits are calculated by applying a calculated cost to retail ratio to the retail value of inventories. The cost of the inventory reflected on the 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, which are reductions in prices due to customers’ perception of value. Accordingly, earnings are negatively impacted as the merchandise is marked down prior to sale.
Inherent in the calculation of inventories are certain significant management judgments and estimates, including setting the original merchandise retail value, markdowns, and estimates of losses between physical inventory counts or shrinkage, which combined with the averaging process within the retail method, can significantly impact the ending inventory valuation at cost and the resulting gross profit.
DSW records a reduction to inventories and charge to cost of sales for shrinkage. Shrinkage is calculated as a percentage of sales from the last physical inventory date. Estimates are based on both historical experience as well as recent physical inventory results. Physical inventory counts are taken on an annual basis and have supported DSW’s shrinkage estimates.
Markdowns establish a new cost basis for DSW’s inventory. Changes in facts or circumstances do not result in the reversal of previously recorded markdowns or an increase in that newly established cost basis. The markdown reserve requires management to make assumptions regarding customer preferences, fashion trends and consumer demand.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation determined by the straight-line method over the expected useful lives of the assets. The straight-line method is used to amortize such capitalized costs over the lesser of the expected useful life of the asset or the life of the lease. The estimated useful lives by class of asset are:
Asset Impairment and Long-Lived Assets
The Company periodically evaluates the carrying amount of its 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 or asset group is considered impaired when the carrying value of the asset or asset group exceeds the expected future cash flows from the asset or asset group. The Company reviews are conducted at the lowest identifiable level, which include a store. The impairment loss recognized is the excess of the carrying value of the asset or asset group over its fair value, based on discounted cash flow analysis using a discount rate determined by management. Should an impairment loss be realized, it will be included in selling, general and administrative expense. There were no impairment charges in fiscal 2010. The Company expensed $0.9 million and $3.3 million in fiscal 2009 and 2008, respectively, of identified assets where the recorded value could not be supported by projected future cash flows. The impairment charges were recorded within the DSW reportable segment.
Self-insurance Reserves
The Company records estimates for certain health and welfare, workers compensation and casualty insurance costs that are self insured programs. Self-insurance reserves include actuarial estimates of both claims filed, carried at their expected ultimate settlement value, and claims incurred but not yet reported. The liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet date. Health and welfare, workers’ compensation and general liability estimates are calculated utilizing claims development estimates based on historical experience and other factors. The Company has purchased stop loss insurance to limit its exposure to any significant exposure on a per person basis for health and welfare and on a per claim basis for workers compensation and general liability. The self-insurance reserves, excluding discontinued operations, were $2.1 million and $2.4 million at the end of fiscal 2010 and 2009, respectively.
Goodwill
Goodwill represents the excess cost over the estimated fair values of net assets including identifiable intangible assets of businesses acquired. As of January 29, 2011 and January 30, 2010, the balance of goodwill related to the DSW stores was $25.9 million. Goodwill is tested for impairment at least annually. Management evaluates the fair value of the reporting unit using market based analysis to review market capitalization as well as reviewing a discounted cash flow analysis using management’s assumptions. Several factors could result in an impairment charge. Failure to achieve sufficient levels of cash flow at the reporting unit level or a significant and sustained decline in DSW’s stock price could result in goodwill impairment charges. Significant judgment is necessary to determine the underlying cause of the decline and whether stock price declines are related to the market or specifically to the Company.
Tradenames and Other Intangible Assets
Tradenames and other intangible assets, net are primarily comprised of values assigned to tradenames. As of January 29, 2011 and January 30, 2010, the gross balance of tradenames was $13.0 million and $12.8 million, respectively. During the year ended January 29, 2011, DSW purchased a merchandise tradename for the amount of $0.2 million, amortizable over five years and an indefinite lived tradename for less than $0.1 million. Accumulated amortization for tradenames was $10.9 million and $10.0 million as of January 29, 2011 and January 30, 2010, respectively. The average useful lives of tradenames and other intangible assets, net are 14 and 15 years as of January 29, 2011 and January 30, 2010, respectively.
Amortization expense for the year ended January 29, 2011 was $0.9 million. Amortization expense associated with the net carrying amount of intangible assets as of January 29, 2011 is $0.9 million for both fiscal 2011 and fiscal 2012, $0.3 million in fiscal 2013 and less than $0.1 million in both fiscal 2014 and fiscal 2015.
Equity Investments
The Company accounts for equity investments using the equity method of accounting when it exercises significant influence over the investment. If the Company does not exercise significant influence, the Company accounts for the investment using the cost method of accounting.
Customer Loyalty Program
The Company maintains a customer loyalty program for the DSW stores and dsw.com in which program members earn reward certificates that result in discounts on future purchases. Upon reaching the target-earned threshold, the members receive reward certificates for these discounts which expire six months after being issued. The Company accrues the anticipated redemptions of the discount earned at the time of the initial purchase. To estimate these costs, DSW is required to make assumptions related to customer purchase levels and redemption rates based on historical experience. The accrued liability included in other accrued expenses as of January 29, 2011 and January 30, 2010 was $12.4 million and $9.0 million, respectively.
Deferred Rent
Many of the Company’s operating leases contain predetermined fixed increases of the minimum rentals during the initial lease terms. For these leases, the Company recognizes the related rental expense on a straight-line basis over the non-cancellable terms of the lease. The Company 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 deferred rent, excluding discontinued operations, included in other non current liabilities was $34.4 million at both January 29, 2011 and January 30, 2010.
Construction and Tenant Allowances
The Company receives cash allowances from landlords, which are deferred and amortized on a straight-line basis over the non-cancellable terms of the lease as a reduction of rent expense. Construction and tenant allowances are included in other non current liabilities and were $60.4 million and $59.7 million as of January 29, 2011 and January 30, 2010, respectively.
Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. The Company presents accumulated other comprehensive loss in its consolidated statements of shareholders’ equity.
The accumulated other comprehensive loss was $5.8 million and $6.9 million at January 29, 2011 and January 30, 2010, respectively, and includes the minimum pension liability and in fiscal year 2009 the unrealized losses on available-for-sale securities. For fiscal 2010, total comprehensive income was $59.5 million. For fiscal 2009, total comprehensive loss was $6.2 million.
Sales and Revenue Recognition
Revenues from merchandise sales are recognized upon customer receipt of merchandise, are net of returns and sales tax and are not recognized until collectability is reasonably assured. For dsw.com, the Company estimates a time lag for shipments to record revenue when the customer receives the goods and also includes revenue from shipping and handling in net sales while the related costs are included in cost of sales.
Revenue from gift cards is deferred and recognized upon redemption of the gift card. The Company’s policy is to recognize income from breakage of gift cards when the likelihood of redemption of the gift card is remote. The Company recognized $1.1 million, $1.1 million and $0.8 million as miscellaneous income from gift card breakage during fiscal 2010, 2009 and 2008, respectively.
Cost of Sales
Cost of sales includes the cost of merchandise, markdowns, and inventory shrinkage. Cost of merchandise includes related inbound freight to our distribution centers, duties, commissions and outbound freight from the distribution centers to our stores and outbound freight of e-commerce sales. The classification of these expenses vary across the retail industry, thus our gross margin rates may not be comparable to those of other retailers that include warehousing and outbound distribution and transportation costs in cost of sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include, and consist primarily of, store, warehousing, distribution and corporate payrolls and benefit costs, occupancy costs which include retail stores, warehousing and corporate rent costs, facility and leasehold improvement depreciation and utility costs, advertising, repair and maintenance, insurance, equipment depreciation, professional fees and other miscellaneous expenses.
Stock-Based Compensation
The fair value of options granted is estimated on the date of grant using the Black-Scholes option pricing model. See Note 4 for a detailed discussion of stock-based compensation.
New Store Costs
Costs associated with the opening of stores are expensed as incurred. New store costs expensed were $2.8 million, $1.6 million and $6.2 million for fiscal 2010, 2009 and 2008, respectively.
Marketing Expense
The production cost of television advertising is expensed when the advertising first takes place. All other marketing costs are expensed as incurred. Marketing costs were $46.5 million, $42.2 million and $30.3 million in fiscal 2010, 2009 and 2008, respectively.
Other Operating Income
The amount recorded in fiscal 2010, 2009 and 2008 was $11.0 million, $5.1 million and $4.2 million, respectively. Other operating income is included in selling, general and administrative expenses in the income statement. Other operating income consists primarily of income from consignment sales, income from gift card breakage and insurance proceeds.
Non-operating Income (Expense), Net
Non-operating income (expense), net includes other-than-temporary impairments related to investments and realized gains on disposition of investments.
Noncontrolling Interests
The noncontrolling interests liability represents the portion of DSW’s total shareholders’ equity owned by unaffiliated investors in DSW. The noncontrolling interests percentage is computed by the ratio of shares held by unaffiliated interests to total shares outstanding. Noncontrolling interest in the statement of operations is calculated using the same ratio.
Earnings Per Share
Basic earnings (loss) per share is based on net income (loss) and a simple weighted average of Common Shares outstanding. Diluted earnings per share reflects the potential dilution of Common Shares, related to outstanding stock options, stock appreciation rights and warrants, calculated using the treasury stock method. See Note 9 for a detailed discussion of earnings per share.
Derivative Financial Instruments
In accordance with ASC 815 Derivatives and Hedging, the Company recognizes all derivatives on the balance sheet at fair value. For derivatives that are not designated as hedges under ASC 815, changes in the fair values are recognized in earnings in the period of change. There were no derivatives designated as hedges outstanding as of January 29, 2011 or January 30, 2010. The Company does not hold or issue derivative financial instruments for trading purposes. Retail Ventures estimates the fair values of derivatives based on the Black-Scholes model using current market information and records all derivatives on the balance sheet at fair value.
Legal Proceedings and Claims
The Company is involved in various legal proceedings that are incidental to the conduct of its business. The Company records a reserve for estimated losses when the loss is probable and the amount can be reasonably estimated. See Note 13 for a discussion of legal matters.
Income Taxes
Income taxes are accounted for using the asset and liability method as required by ASC 740, Income Taxes. The Company is 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 in which we do business. In making these estimates, income is adjusted 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 the Company’s 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 management had made these determinations on a different basis, the tax expense, assets and liabilities could be different. During fiscal 2010, a decrease in valuation reserve of $2.4 million for deferred tax assets was recorded. During fiscal 2009, an increase in valuation reserve of $41.1 million for deferred tax assets was recorded.
Sale of subsidiary stock
Sales of stock by a subsidiary are accounted for by Retail Ventures as capital transactions.
Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (“FASB”) issued an update to ASC 805 Business Combinations related to noncontrolling interests in consolidated financial statements. This guidance establishes accounting and reporting standards for the noncontrolling interest in a subsidiary (previously referred to as minority interest) and for the deconsolidation of a subsidiary. This guidance shall be applied prospectively as of the beginning of the fiscal year in which this statement is initially adopted, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. This guidance was effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with early adoption prohibited. The adoption of this guidance during the first quarter of fiscal year 2009 resulted in enhanced disclosures regarding the minority interests of DSW as well as some presentation changes of noncontrolling interest within the balance sheets, statements of operations and statements of changes in shareholders’ equity.
In June 2008, the FASB issued an update to ASC 815-40 Derivatives and Hedging, Contracts in Entity’s Own Equity related to determining whether an instrument (or embedded feature) is indexed to an entity’s own stock. This guidance was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, with early adoption prohibited. ASC 815-10 Derivatives and Hedging topic specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. ASC 815-40 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the ASC 815-10 scope exception. The adoption of this guidance during the first quarter of fiscal year 2009 resulted in the redesignation and reclassification of the VCHI Warrants from Equity to Liability within the balance sheets. In addition, the VCHI Warrants were marked to market as of the date of the adoption and continued to be marked to market through their expiration date.
In January 2010, the FASB issued updates to existing guidance related to fair value measurements. As a result of these updates, entities will be required to provide enhanced disclosures about transfers into and out of level 1 and level 2 classifications, provide separate disclosures about purchases, sales, issuances and settlements relating to the tabular reconciliation of beginning and ending balances of the level 3 classification and provide greater disaggregation for each class of assets and liabilities that use fair value measurements. Except for the detailed level 3 disclosures, the new standard was effective for the Company for the first quarter of fiscal 2010. The requirement related to level 3 fair value measurements is effective for the Company for interim and annual reporting periods beginning after January 29, 2011. The adoption of the effective portions of this new standard did not have a material impact to the Company’s consolidated financial statements and the Company does not expect a material impact to its consolidated financial statements related to the level 3 fair value disclosures.
2. DISCONTINUED OPERATIONS
Value City
On January 23, 2008, Retail Ventures disposed of an 81% ownership interest in its Value City operations to VCHI Acquisition Co., a newly formed entity owned by VCDS Acquisition Holdings, LLC, Emerald Capital Management LLC and Crystal Value, LLC. As part of the transaction, Retail Ventures issued warrants to VCHI Acquisition Co. to purchase 150,000 RVI Common Shares, at an exercise price of $10.00 per share, and exercisable within 18 months of January 23, 2008. The warrants expired in June 2009. Retail Ventures received no net cash proceeds from the sale and paid a fee of $0.5 million to the purchaser.
Retail Ventures recognized an aggregate after-tax loss related to the Value City disposition of $64.5 million as of January 29, 2011, including a reduction in the loss of $2.7 million recognized in the year ended January 29, 2011. The fiscal 2010 reduction of the loss consisted primarily of revaluations of the liabilities for the guarantees recorded by Retail Ventures due to information available indicating that it was no longer probable that the guaranteed liability would be incurred.
The fiscal 2009 reduction of the loss of $9.5 million consisted primarily of revaluations of the liabilities for the guarantees recorded by Retail Ventures due to payments by the primary obligor to the guaranteed party or information available indicating that it was no longer probable that the guaranteed liability or other liability would be incurred.
The fiscal 2008 reduction of the loss of $13.2 million related to the Value City disposition also consisted primarily of revaluations of the liabilities for the guarantees recorded by Retail Ventures due to payments by the primary obligor to the guaranteed party or information available indicating that it was no longer probable that the guaranteed liability or other liability would be incurred partially offset by additional expenses relating to the transaction.
See Note 13 for additional discussion regarding the guarantees.
The following table presents the significant components of the income from discontinued operations attributed to Value City (in thousands):
Filene’s Basement
On April 21, 2009, RVI disposed of its Filene’s Basement operations. RVI did not realize any cash proceeds from this transaction and agreed to pay a fee of $1.3 million to Buxbaum, which has been paid, and reimbursed $0.4 million of Buxbaum’s costs associated with the transaction. RVI also agreed to indemnify Buxbaum, FB II Acquisition Corp. and their owners against certain liabilities. As of January 29, 2011, RVI had recorded a liability of $0.2 million under lease obligations related to leases not assumed by New Filene’s Basement. RVI has recognized an after-tax gain of $85.8 million on the transaction as of January 29, 2011. The $85.8 million gain on the disposition of Filene’s Basement is comprised of the following (in thousands):
In accordance with SAB Topic 5, Accounting for Sales of Stock by a subsidiary, changes in the carrying value of assets with residual interest in the discontinued business should be classified within continuing operations. The other accounts receivable from Filene’s Basement existed prior to the disposition of Filene’s Basement and the notes receivable and related interest receivable from Filene’s Basement were not forgiven pursuant to the disposition transaction, but as a result of the Filene’s Basement filing for bankruptcy after the disposition transaction. Therefore, the Company has recorded a full reserve in the amount of $57.3 million for the notes receivable, related interest receivable and other accounts receivable from Filene’s Basement in selling, general and administrative expenses within continuing operations.
On August 16, 2006, Filene’s Basement entered into a Promissory Note with Retail Ventures for $27.6 million, due August 16, 2013. In addition, on January 3, 2008, Filene’s Basement entered into a Promissory Note with Retail Ventures for $25.0 million, due February 1, 2013. Each note between Filene’s Basement and Retail Ventures provided for interest to accrue at 13% per annum.
On May 4, 2009, liquidating Filene’s Basement filed for bankruptcy protection. As a result of the filing, RVI determined that the notes receivable from liquidating Filene’s Basement, the related accrued interest receivable and accounts receivable from liquidating Filene’s Basement were fully impaired and recorded bad debt expense of $57.3 million related to these assets. Effective November 3, 2009, RVI’s claims against liquidating Filene’s Basement in respect of these notes receivables were released in connection with a Settlement Agreement approved by the bankruptcy court. In addition, DSW recorded bad debt expense related to the impairment of certain accounts receivable from liquidating Filene’s Basement of $0.6 million. Therefore, included in the consolidated results of operations of RVI for the twelve months ended January 30, 2010, is bad debt expense of $57.9 million related to the impairment of these items.
The following table presents the significant components of Filene’s Basement operating results included in discontinued operations (in thousands):
3. RELATED PARTY TRANSACTIONS
As of January 29, 2011, SSC and its affiliates, in the aggregate, owned approximately 50.6% of the outstanding RVI Common Shares and beneficially owned approximately 52.3% (assumes the issuance of 1,731,460 RVI Common Shares issuable upon the exercise of warrants held by Schottenstein RVI, LLC).
The Company leases certain store, office space and distribution center locations owned by entities affiliated with SSC. Accounts receivable from and payable to affiliates principally result from commercial transactions with entities owned or affiliated with SSC or intercompany transactions with SSC and normally settle in the form of cash in 30 to 60 days. These related party balances as of January 29, 2011 and January 30, 2010, were related party receivables of $0.1 million and $0.2 million, respectively and as of January 29, 2011 and January 30, 2010 were related party payables of $1.1 million and 1.2 million, respectively. See Notes 6, 7 and 12 to the consolidated financial statements for additional related party disclosures.
In fiscal 2009, DSW made an equity investment of $1.2 million and the majority interest is held by an affiliate of SSC. DSW received a return on capital of $0.2 million in fiscal 2010. There was no income statement impact in fiscal 2009 or fiscal 2010 related to this investment.
Purchases from affiliates were $0.4 million, $0.2 million and $0.1 million in fiscal 2010, 2009 and 2008, respectively.
4. STOCK BASED COMPENSATION
On January 29, 2006, Retail Ventures adopted the fair value recognition provisions of ASC 718 Compensation - Stock Compensation relating to its stock-based compensation plans. Prior to January 29, 2006, compensation expense for employee stock options was generally not recognized for options granted that had an exercise price equal to the market value of the underlying Common Shares on the date of grant.
Under the modified prospective method of ASC 718, compensation expense was recognized for stock option awards granted subsequent to the adoption of ASC 718 on a straight-line basis over the requisite service period of the award. Prior to the adoption of ASC 718, compensation expense for stock option awards granted was recorded using an accelerated method. Stock-based compensation expense was recorded in selling, general and administrative expenses in the Consolidated Statements of Operations. Retail Ventures’ financial results for the prior periods have not been restated as a result of this adoption.
Consistent with the valuation method used for the disclosure only provisions of ASC 718, the Company is using the Black-Scholes option-pricing model to value stock-based compensation expense. This model assumes that the estimated fair value of options is amortized over the options’ vesting periods and the compensation costs would be included in selling, general and administrative costs in the Consolidated Statements of Operations. RVI recognizes compensation expense for stock option awards granted subsequent to the adoption of ASC 718 and time-based restricted stock awards on a straight-line basis over the requisite service period of the award. Compensation expense for stock option awards granted prior to the adoption of ASC 718 is recorded using an accelerated method.
Retail Ventures Stock Compensation Plans
Retail Ventures has a 2000 Stock Incentive Plan (“the RVI Plan”) that provides for the issuance of stock options to purchase up to 13,000,000 common shares or the issuance of restricted stock to management, key employees of Retail Ventures and affiliates, consultants (as defined in the RVI Plan), and directors of Retail Ventures. Stock options generally vest 20% per year on a cumulative basis. Stock options granted under the RVI Plan remain exercisable for a period of ten years from the date of grant. As of January 29, 2011, 4.6 million shares are available for additional grants under the Plan.
A stock option to purchase 2,500 common shares is automatically granted to each non-employee RVI director on the first NYSE trading day in each calendar quarter. The exercise price for each stock option is the fair market value of the common shares on the date of grant. All stock options become exercisable one year after the grant date and remain exercisable for a period of ten years from the grant date, subject to continuation of the option holders’ service as directors of Retail Ventures.
Retail Ventures had a 1991 Stock Option Plan. As of January 29, 2011, there were no outstanding options under this plan.
Stock Options
Retail Ventures expensed $0.5 million, $0.3 million and $0.3 million in fiscal 2010, fiscal 2009 and fiscal 2008, respectively, related to RVI stock options.
Forfeitures of options are estimated at the grant date based on historical rates and reduce the compensation expense recognized. The risk-free interest rate is based on the yield for the U.S. Treasury securities with a remaining life equal to the expected term of the options at the grant date. Expected volatility is based on the historical volatility of Retail Ventures Common Shares. The expected term of options granted is derived from historical data on RVI stock option exercises. The expected dividend yield is zero, which is based on the Company’s history and current intent of not declaring dividends to shareholders.
The following table illustrates the weighted-average assumptions used in the Black-Scholes option-pricing model for RVI stock options granted in each of the periods presented:
The following tables summarize the Company’s stock option plan activity and related per share Weighted Average Exercise Prices (“WAEP”), weighted average remaining contractual life and aggregate intrinsic value for the fiscal years ended January 29, 2011, January 30, 2010 and January 31, 2009 (shares and intrinsic value in thousands):
The weighted-average grant date fair value of options granted in fiscal 2010, fiscal 2009 and fiscal 2008 was $7.42 per share, $2.53 per share and $1.52 per share, respectively. The aggregate intrinsic value is calculated as the amount by which the fair value of the underlying common shares exceeds the option exercise price. Total intrinsic value of options exercised during fiscal 2010, 2009 and 2008 was $0.1 million, $0.2 million and $0.2 million, respectively. The total fair value of options that vested during fiscal 2010, 2009 and 2008 was $0.1 million, $0.1 million and $0.5 million, respectively.
As of January 29, 2011, the total compensation cost related to nonvested RVI stock options not yet recognized was approximately $0.2 million with a weighted-average expense recognition period remaining of 0.6 years.
Stock Appreciation Rights (SARS)
Retail Ventures expensed negative $1.0 million, $0.7 million and $1.1 million in fiscal 2010, fiscal 2009 and fiscal 2008, respectively, related to RVI SARs.
The SARs are subject to an Option Price Protection Provision (“OPPP”) which provides that until the Company receives certain approvals from its lenders, the issuance of the options underlying the SARs is contingent. Further, if any of these SARs would have vested before they are actually granted, at or after that time, the grantee may exercise the OPPP on some or all of the SARs that would have vested. Pursuant to an exercise of SARs, the grantee is compensated by the Company in the amount of the gain, if any, represented by the difference between the closing price of the RVI Common Shares on the New York Stock Exchange on the date of the exercise and the strike price per share. The OPPP does not apply once SARs are actually granted. SARs are granted to employees and are subject to a vesting schedule or a performance vesting formula, as applicable. Prior to fiscal 2007, SARs were recorded as liabilities in the balance sheets due to their ability to be settled in cash or Common Shares and the historical exercises being settled in cash.
SARs generally vest ratably over five years although some of the more recent grants vest over a three year period with 50% vesting at the end of the third year. The exercise price is equal to the fair market value on the date of the grant.
There were no SARS granted in fiscal 2010, fiscal 2009 or fiscal 2008.
The following tables summarize the Company’s SARS activity and related per share Weighted Average Exercise Prices (“WAEP”), weighted average remaining contractual life and aggregate intrinsic value for the fiscal years ended January 29, 2011, January 30, 2010 and January 31, 2009 (shares and intrinsic value in thousands):
The aggregate intrinsic value is calculated as the amount by which the fair value of the underlying common shares exceeds the SARS exercise price. Total intrinsic value of SARS exercised during fiscal 2010 and 2009 was $0.1 million and less than $0.1 million. There were no SARS exercised during fiscal 2008. The total fair value of SARS that vested during fiscal 2010, fiscal 2009 and fiscal 2008 was $0.1 million, $0.7 million and $1.1 million, respectively.
As of January 29, 2011, the total compensation cost related to nonvested RVI SARS not yet recognized was less than $0.1 million with a weighted-average expense recognition period remaining of 1.1 years.
Restricted Stock Units
Retail Ventures expensed less than $0.1 million during fiscal 2010, fiscal 2009 and fiscal 2008 related to RVI restricted stock units.
The Company issues restricted stock units to certain executives of the Company. The restricted stock units issued by Retail Ventures, generally vest over three years, in one-third increments per year and are settled immediately upon vesting. The restricted stock units are settled only in cash in an amount equal to the fair market value of an equivalent number of the Company’s Common Shares on the date of vesting. The restricted stock units provide that no Common Shares of the Company will be issued, authorized, reserved, purchased or sold at any time in connection with the restricted stock units. The restricted stock units are under no circumstances considered Common Shares nor do they entitle the holder of the restricted stock units to the exercise of any other rights arising from the ownership of Common Shares, including dividend and voting rights.
There were no restricted stock units accrued at January 29, 2011. The amount of restricted stock units accrued was less than $0.1 million at January 30, 2010. The Company paid $0.1 million in fiscal 2010 and fiscal 2008 and less than $0.1 million in fiscal 2009 to settle vested restricted stock units.
The following tables summarize the Company’s restricted stock units activity for the fiscal years ended January 29, 2011, January 30, 2010 and January 31, 2009 (units in thousands):
Restricted Shares
Retail Ventures expensed $0.6 million during fiscal 2010 related to RVI restricted shares. There was no expense related to RVI restricted shares during fiscal 2009 or fiscal 2008.
Retail Ventures issues restricted common shares to certain key employees pursuant to individual employment agreements and certain other grants from time to time, which are approved by the Board of Directors. The agreements condition the vesting of the RVI restricted shares generally upon continued employment with Retail Ventures with such restrictions generally expiring over one to three years. The market value of the RVI restricted shares at the date of grant is charged to expense on a straight-line basis over the period that the restrictions lapse.
As of January 29, 2011, Retail Ventures had 70,000 restricted shares outstanding. The weighted-average grant date fair value of restricted shares granted in fiscal 2010 was $8.86 per share.
As of January 29, 2011, the total compensation cost related to nonvested RVI restricted shares not yet recognized was approximately $0.1 million with a weighted-average expense recognition period remaining of 0.1 years. The weighted-average exercise price for all RVI restricted shares is zero.
DSW Stock Compensation Plan
DSW has a 2005 Equity Incentive Plan (“the DSW Plan”) that provides for the issuance of equity awards to purchase up to 7.6 million DSW Common Shares. The DSW Plan covers stock options, restricted stock units and director stock units. Eligible recipients include key employees of DSW and affiliates, as well as directors of DSW. Stock options generally vest 20% per year on a cumulative basis. Stock options granted under the DSW Plan generally remain exercisable for a period of ten years from the date of grant. Prior to fiscal 2005, DSW did not have a stock option plan or any equity units outstanding. As of January 29, 2011, 4.0 million shares are available for additional grants under the Plan.
Stock Options
Included in the consolidated statements of operations is expense of $3.7 million, $4.2 million and $3.8 million for fiscal 2010, fiscal 2009 and fiscal 2008, respectively, related to DSW stock options.
DSW uses the Black-Scholes option-pricing model to value stock-based compensation expense. This model assumes that the estimated fair value of options is amortized over the options’ vesting periods and the compensation costs are included in operating expenses in the consolidated statements of income. DSW recognizes compensation expense for stock option awards granted subsequent to the adoption of ASC 718 Compensation - Stock Compensation and time-based restricted stock awards on a straight-line basis over the requisite service period of the award. Prior to the adoption of ASC 718, compensation expense for stock option awards granted was recorded using an accelerated method.
Forfeitures of options are estimated at the grant date based on historical rates and reduce the compensation expense recognized. The risk-free interest rate is based on the yield for U.S. Treasury securities with a remaining life equal to the expected term of the options at the grant date. Expected volatility is based on the historical volatility of the DSW Common Shares. The expected term of options granted is derived from historical data on DSW stock option exercises. The expected dividend yield is zero, which is based on DSW’s intention of not declaring dividends to shareholders combined with the limitations on declaring dividends as set forth in DSW’s Credit Facility.
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:
The following tables summarizes DSW’s stock option plan activity and related per share weighted average exercise prices (“WAEP”), weighted average remaining contractual life and aggregate intrinsic value for the fiscal years ended January 29, 2011, January 30, 2010 and January 31, 2009 (shares and intrinsic value in thousands):
The weighted average grant date fair value of each option granted in fiscal 2010, 2009 and 2008 was $13.40, $5.10 and $5.77, respectively. The aggregate intrinsic value is calculated as the amount by which the fair value of the underlying common shares exceeds the option exercise price. The total intrinsic value of options exercised during fiscal 2010 and 2009 was $4.6 million and $0.4 million, respectively. This amount was immaterial in fiscal 2008. The total fair value of options that vested during fiscal 2010, 2009 and 2008 was $4.2 million, $4.3 million and $3.6 million, respectively.
As of January 29, 2011, the total compensation cost related to nonvested options not yet recognized was approximately $9.4 million, with a weighted average expense recognition period remaining of 3.3 years.
Restricted Stock Units
Restricted stock units generally cliff vest at the end of four years from the date of grant and are settled immediately upon vesting. The weighted average exercise price for all restricted stock units is zero. Restricted stock units granted to employees that are subject to the risk of forfeiture are not included in the computation of basic earnings per share.
Compensation cost is measured at fair value on the grant date and recorded over the vesting period. Fair value is determined by multiplying the number of units granted by the grant date market price. DSW expensed $0.3 million, $1.3 million and $0.7 million, respectively, in fiscal 2010, 2009 and 2008 related to restricted stock units. The weighted average exercise price for all restricted stock units is zero. The aggregate intrinsic value is calculated as the amount by which the fair value of the underlying common shares exceeds the exercise price. The total intrinsic value of restricted stock units that vested during fiscal 2010, 2009 and 2008 was $1.0 million, $0.8 million and $0.1 million, respectively. The total fair value of restricted stock units that vested during fiscal 2010, fiscal 2009 and fiscal 2008 was $0.6 million, $1.7 million and $0.2 million, respectively. As of January 29, 2011, the total compensation cost related to nonvested restricted stock units not yet recognized was approximately $1.6 million with a weighted average expense recognition period remaining of 2.4 years.
The following tables summarize DSW’s restricted stock units activity and related weighted average grant date Fair Value (“GDFV”) and aggregate intrinsic value for the fiscal years ended January 29, 2011, January 30, 2010 and January 31, 2009 (units and intrinsic value in thousands):
Director Stock Units
DSW issues stock units to directors who are not employees of DSW or RVI. During fiscal 2010, 2009 and 208, DSW granted 31,562, 46,504 and 45,265 director stock units, respectively, and expensed $0.9 million, $0.6 million and $0.6 million, respectively, related to these grants. Stock units are automatically granted to each director who is not an employee of DSW or RVI on the date of each annual meeting of shareholders for the purpose of electing directors. The number of stock units granted to each non-employee director is calculated by dividing one-half of the director’s annual retainer (including committee retainer fees but excluding any amount paid for service as the chair of a board committee) by the fair market value of a share of the DSW Class A Common Shares on the date of the annual meeting. In addition, each director eligible to receive compensation for board service may elect to have the cash portion of such directors’ compensation paid in the form of stock units. Stock units granted to directors vest immediately and are settled upon the director terminating service from the board. Stock units granted to directors which are not subject to forfeiture are considered to be outstanding for the purposes of computing basic earnings per share. The exercise price of the director stock units is zero. As of January 29, 2011, 161,267 director stock units had been issued and no director stock units had been settled.
5. INVESTMENTS
DSW determines the balance sheet classification of its investments at the time of purchase and evaluates the classification at each balance sheet date. If DSW has the intent and ability to hold the investments to maturity, investments are classified as held-to-maturity. Held-to-maturity securities are stated at amortized cost plus accrued interest. Otherwise, investments are classified as available-for-sale. The majority of the Company’s short-term available-for-sale investments generally have renewal dates of every 7 days and longer stated maturities. Despite the long-term nature of the stated contractual maturities of these short-term investments, the Company has the ability to liquidate these securities shortly after the renewal dates. For short-term held-to-maturity investments, amortized cost approximates fair value. In addition to short-term investments, the Company has invested in certain longer term bonds to receive higher returns. These long-term investments have maturities greater than one year but shorter than two years and are classified as held-to-maturity. As of January 29, 2011 DSW’s long-term held-to-maturity investments have a gross unrealized loss of $0.1 million and immaterial gross unrealized gains.
In fiscal 2010, DSW sold its fully impaired auction rate security for a gain of $1.5 million and also received a return of capital of $0.2 million related to its related party equity investment. In fiscal 2009, DSW received preferred shares as distributions-in-kind on two of its auction rate securities. DSW sold these preferred shares during fiscal 2009 for realized gains of $0.5 million, excluding the other-than-temporary impairments previously recorded. For fiscal 2009, DSW recorded a full other-than-temporary impairment related to its auction rate security due to the unfavorable financial condition of the underlying issuer.
The following table discloses the major categories of the DSW’s investments as of January 29, 2011 and January 30, 2010 (in thousands):
6. LEASES
The Company leases stores, office space, and distribution and fulfillment centers under various arrangements with related and unrelated parties. Such leases expire through 2027 and in most cases provide for renewal options. Generally, the Company is required to pay base rent, real estate taxes, maintenance, insurance and contingent rentals based on sales in excess of specified levels. As of January 29, 2011 and January 30, 2010, the Company had no capital leases.
As of January 29, 2011, the Company leased or had other agreements with entities affiliated with SSC for 21 store locations, our office facilities, a trailer parking lot, one fulfillment center and one distribution center for a total annual minimum rent of $11.5 million and additional contingent rents based on aggregate sales in excess of specified sales for the store locations. Under supply agreements, the Company pays contingent rents based on sales for the leased departments it operates.
The following table presents future minimum lease payments required under the aforementioned leases, exclusive of real estate taxes, insurance and maintenance costs, at January 29, 2011 (in thousands):
The following table presents the composition of rental expense for the periods presented (in thousands):
7. LONG TERM OBLIGATIONS
Long term obligations consist of the following (in thousands):
The Company is not subject to any financial covenants; however, its credit facilities contain numerous restrictive covenants relating to the Company’s management and operation. These non-financial covenants include, among other restrictions, limitations on indebtedness, guarantees, mergers, acquisitions, fundamental corporate changes, financial reporting requirements, budget approval, disposition of assets, investments, loans and advances, liens, dividends, stock purchases, transactions with affiliates, issuance of securities and the payment of and modifications to debt instruments under these agreements.
DSW $100 Million Credit Facility
On June 30, 2010, DSW entered into a $100 million secured revolving credit facility (the “DSW Credit Facility”) with a term of four years that will expire on June 30, 2014. This facility replaced an existing $150 million secured revolving credit facility (the “Previous DSW Credit Facility”) that expired July 5, 2010. Under the DSW Credit Facility, DSW and its subsidiary, DSW Shoe Warehouse, Inc. (“DSWSW”), are co-borrowers, with all other subsidiaries listed as guarantors. The DSW Credit Facility may be increased by up to $75 million upon DSW’s request and approval by increasing lenders and subject to customary conditions. The DSW Credit Facility provides for swing loans of up to $10 million and the issuance of letters of credit up to $50 million. The DSW Credit Facility is secured by a lien on substantially all of DSW’s personal property assets and its subsidiaries with certain exclusions and may be used to provide funds for general corporate purposes, to refinance existing letters of credit outstanding under DSW’s previous credit arrangement, to provide for DSW’s ongoing working capital requirements, and to make permitted acquisitions. Revolving credit loans bear interest under the DSW Credit Facility at DSW’s option under: (A) a base rate option at a rate per annum equal to the highest of (i) the Federal Funds Open Rate (as defined in the DSW Credit Agreement), plus 0.5%, (ii) the Agent’s prime rate, and (iii) the Daily LIBOR Rate (as defined in the DSW Credit Agreement) plus 1.0%, plus in each instance an applicable margin based upon DSW’s revolving credit availability; or (B) a LIBOR option at rates equal to the one, two, three, or six month LIBOR rates, plus an applicable margin based upon DSW’s revolving credit availability. Swing loans bear interest under the base rate option. DSW’s right to obtain advances under the DSW Credit Facility is limited by a borrowing base. In addition, the DSW Credit Facility contains restrictive
covenants relating to DSW’s management and the operation of DSW’s business. These covenants, among other things, limit or restrict DSW’s ability to grant liens on its assets, incur additional indebtedness, enter into transactions with affiliates, merge or consolidate with another entity, redeem its stock and limit cash dividends up to the aggregate amount of 50% of the previous year’s net income, not to exceed $50.0 million. Additional covenants limit payments for capital expenditures to $75.0 million in any fiscal year, and if DSW has direct borrowings greater than $25.0 million, its credit facility also requires that DSW maintain a fixed charge coverage ratio of not less than 1.1 to 1.0. DSW paid $46.7 million for capital expenditures in fiscal 2010. DSW was not required to maintain a fixed charge coverage ratio in fiscal 2010.
As of January 29, 2011, DSW had no outstanding borrowings, had availability under the DSW Credit Facility of $80.8 and had outstanding letters of credit of $19.2 million. As of January 30, 2010 under its previous credit facility, DSW had no outstanding borrowings, had availability under the Previous DSW Credit Facility of $132.6 million and had outstanding letters of credit of $17.4 million. DSW is in compliance with the covenants under the DSW Credit Facility.
Net restricted assets as of January 29, 2011 and January 30, 2010 were $243.5 million and $197.4 million, respectively. Refer to Schedule I for condensed financial information of parent company.
Total interest expense related to DSW was $1.0 million, $1.4 million and $0.8 million for fiscal 2010, 2009 and 2008, respectively, and included fees, such as commitment and line of credit fees of $0.5 million in each respective period.
$143,750,000 Premium Income Exchangeable SecuritiesSM (PIES)
On August 10, 2006, Retail Ventures announced the pricing of its 6.625% Mandatorily Exchangeable Notes due September 15, 2011, or PIES in the aggregate principal amount of $125,000,000. The closing of the transaction took place on August 16, 2006. On September 15, 2006, Retail Ventures closed on the exercise by the sole underwriter of its entire option to purchase an additional aggregate principal amount of $18,750,000 of PIES. The $143,750,000 PIES bear a coupon at an annual rate of 6.625% of the principal amount, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing on December 15, 2006 and ending on September 15, 2011. Except to the extent RVI exercises its cash settlement option, the PIES are mandatorily exchangeable, on the maturity date, into Class A Common Shares of DSW, no par value per share, which are issuable upon exchange of DSW Class B Common Shares, no par value per share, beneficially owned by RVI. On the maturity date, each holder of the PIES will receive a number of DSW Class A Common Shares per $50.00 principal amount of PIES equal to the “exchange ratio” described in the RVI prospectus filed with the SEC on August 11, 2006, or if RVI elects, the cash equivalent thereof or a combination of cash and DSW Class A Common Shares. The exchange ratio is equal to the number of DSW Class A Common Shares determined as follows: (i) if the applicable market value of DSW Class A Common Shares equals or exceeds $34.95, the exchange ratio will be 1.4306 shares; (ii) if the applicable market value of DSW Class A Common Shares is less than $34.95 but greater than $27.41, the exchange ratio will be between 1.4306 and 1.8242 shares; and (iii) if the applicable market value of DSW Class A Common Shares is less than or equal to $27.41, the exchange ratio will be 1.8242 shares, subject to adjustment as provided in the PIES. The maximum aggregate number of DSW Class A Common Shares deliverable upon exchange of the PIES is 5,244,575 DSW Class A Common Shares, subject to adjustment as provided in the PIES.
The embedded exchange feature of the PIES is accounted for as a derivative, which is recorded at fair value with changes in fair value in the statement of operations. Accordingly, the accounting for the embedded derivative addresses the variations in the fair value of the obligation to settle the PIES when the market value exceeds or is less than the threshold appreciation price. The fair value of the conversion feature at the date of issuance of $11.7 million was equal to the amount of the discount of the PIES and will be amortized into interest expense over the term of the PIES.
As of January 29, 2011, the discount on the PIES has a remaining amortization period of 0.6 years. The amount of interest expense recognized and the effective interest rate for the PIES were as follows (in thousands):
On October 10, 2008, Retail Ventures repurchased 200,000 units of PIES for an aggregate purchase price of $5.6 million, which resulted in a reduction of the long-term obligation of $10.0 million. Retail Ventures recorded a gain of $1.5 million on the repurchase which is included in non-operating income on the statements of operations.
During fiscal 2010, the Company recorded a non-cash charge of $34.4 million related to the change in fair value of the conversion feature of the PIES. During fiscal 2009 and 2008, the Company recorded a non-cash charge of $49.7 and a non-cash reduction of expense of $49.3, respectively, related to the change in fair value of the conversion feature of the PIES. As of January 29, 2011, the fair value liability recorded for the conversion feature of the PIES was $6.4 million. As of January 30, 2010, the fair value asset recorded for the conversion feature of the PIES was $28.0 million. The fair value of the conversion feature of the PIES at January 29, 2011 and January 30, 2010 was estimated using the Black-Scholes Pricing Model with the following assumptions:
Other Debt Items
The weighted average interest rate on borrowings under the Company’s credit facilities, excluding discontinued operations, during the fiscal years 2010, 2009 and 2008 was 6.6%.
The book value of notes payable and long-term debt approximates fair value at January 29, 2011. The carrying amount of the term loan and subordinated debt also approximates fair value.
At January 29, 2011, future annual long-term debt payments are as follows (in thousands):
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, DSW 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.
The following table presents financial assets and liabilities measured at fair value on a recurring basis as of the periods presented (in thousands):
Cash and equivalents primarily represent cash deposits and investments in money market funds held with financial institutions, as well as credit card receivables that generally settle in less than three days. Available-for-sale and held-to-maturity investments are valued using a market-based approach using level 2 inputs such as prices of similar assets in active markets. Equity investments are evaluated for other-than-temporary impairment using level 3 inputs such as the financial condition and future prospects of the entity.
The following table presents the activity related to level 3 fair value measurements for the periods presented (in thousands):
Long-lived assets held and used with a carrying amount of $1.9 million were written down to their fair value of $1.0 million, resulting in an impairment charge of $0.9 million, which was included in earnings for the fiscal year ended January 30, 2010. There were no impairment charges in fiscal 2010.
The Company periodically evaluates the carrying amount of its 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 or asset group is considered impaired when the carrying value of the asset or asset group exceeds the expected future cash flows from the asset or asset group. The Company reviews are conducted at the lowest identifiable level, which include a store. The impairment loss recognized is the excess of the carrying value of the asset or asset group over its fair value, based on a discounted cash flow analysis using a discount rate determined by management. Should an impairment loss be realized, it will be included in selling, general and administrative expense. The impairment charges were recorded within the DSW reportable segment.
The fair values and balance sheet locations of the Company’s derivative assets (liabilities) are as follows (in thousands):
The effect of derivative instruments on the Company’s condensed consolidated statements of operations is as follows (in thousands):
9. EARNINGS PER SHARE
Basic earnings per share is based on net income (loss) and a simple weighted average of Common Shares outstanding. Diluted earnings per share reflects the potential dilution of common shares, related to outstanding RVI stock options, SAR’s and Warrants calculated using the treasury stock method. The following is a reconciliation of the net income (loss) and number of shares used in the calculation of diluted earnings (loss) per share computations at January 29, 2011, January 30, 2010 and January 31, 2009 (in thousands except per share amounts):
The amount of securities outstanding at January 29, 2011, January 30, 2010 and January 31, 2009 that were not included in the computation of dilutive earnings per share because the equity unit’s exercise price was greater than the average market price of the Common Shares for the period and, therefore, the effect would be anti-dilutive, was as follows (in thousands):
10. PENSION BENEFIT PLANS
The Company has one qualified defined benefit pension plan assumed at the time of the bankruptcy court’s approval of the Company’s settlement agreement with Filene’s Basement. The Company’s funding policy is to contribute annually the amount required to meet ERISA funding standards and to provide not only for benefits attributed to service to date but also for those anticipated to be earned in the future. The Company uses a January 31 measurement date for its plan.
The following provides a reconciliation of projected benefit obligations, plan assets and funded status of the plan for the years as noted below (in thousands):
The Company made contributions of $0.5 million to the pension plan during fiscal 2010. The Company made no contributions during fiscal 2009. The Company’s funding policy is to contribute an amount annually that satisfies the minimum funding requirements of ERISA and that is tax deductible under the Internal Revenue Code of 1986, as amended
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid in the years indicated (in thousands):
Amounts recognized in the Consolidated Balance Sheets consisted of the following (in thousands):
Included in accumulated other comprehensive loss are deferred tax assets of $3.9 million and $2.9 million as of January 29, 2011 and January 30, 2010, respectively.
The components of net periodic benefit cost are comprised of the following for the years indicated (in thousands):
Of the amounts in accumulated other comprehensive loss as of January 29, 2011, we expect the following to be recognized as net pension costs in fiscal 2011 (in thousands):
The expected long-term rate of return was based on historical average annual returns for S&P 500, Russell 2000 and Barclay Capital for 5 years and 10 years and since inception of the assets. Assumptions used in each year of the actuarial computations were:
The Company’s investment strategy is to meet the liabilities of the plan as they are due and to maximize the return on invested assets within appropriate risk tolerances. The targeted allocation ranges of plan assets by category are as follows:
The weighted average allocation of plan assets by category is as follows:
As discussed in Note 8 of Notes to Consolidated Financial Statements, 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.
The following table presents the activity related to fair value measurements of pension plan assets for the periods presented:
11. OTHER BENEFIT PLANS
The Company participates in a 401(k) Plan (the “Plan”). Eligible employees may contribute up to thirty percent of their compensation to the Plan, on a pre-tax basis, subject to Internal Revenue Service limitations. As of the first day of the month following an employee’s completion of one year of service as defined under the terms of the Plan, DSW matches employee deferrals into the Plan, 100% on the first 3% of eligible compensation deferred and 50% on the next 2% of eligible compensation deferred. Additionally, the Company may contribute a discretionary profit sharing amount to the Plan each year but has not for the past three fiscal years. The Company incurred costs associated with the Plan, excluding discontinued operations, of $1.9 million, $1.8 million and $2.0 million for fiscal years 2010, 2009 and 2008, respectively.
12. WARRANTS
Warrants
The detached warrants with dual optionality issued in connection with previously paid credit facilities qualified as derivatives under ASC 815, Derivatives and Hedging. The fair values of the warrants have been recorded on the balance sheet within current liabilities. As of January 29, 2011, the Company had outstanding 1,952,498 warrants and as of January 30, 2010, the Company had outstanding 3,683,959 warrants. On June 10, 2009, the 8,333,333 outstanding Conversion Warrants expired and Retail Ventures repaid in full the $250,000 remaining balance along with the related accrued interest on the Senior Non-Convertible Loan, as amended and restated on August 16, 2006, made by Schottenstein Stores Corporation in favor of Value City, which loan was assumed by RVI in connection with the disposition of its 81% ownership interest in the Value City operations on January 23, 2008. The warrants outstanding as of January 29, 2011 expire on June 11, 2012.
During fiscal 2010, Retail Ventures issued 1,214,572 of its Common Shares at an exercise price of $4.50 per share to Cerberus in connection with Cerberus’ exercise of its remaining Conversion Warrants. In connection with this cashless exercise, Retail Ventures did not receive any cash and reclassified $17.1 million from the warrant liability to paid in capital during fiscal 2010.
For fiscal 2010, the Company recorded a non-cash charge of $14.6 million for the change in fair value of warrants, of which the portion held by related parties was a non-cash charge of $13.0 million. For fiscal 2009 and fiscal 2008, the Company recorded a non-cash charge of $16.8 million and a non-cash reduction of expense of $35.9 million, respectively, for the change in fair value of warrants, of which the portion held by related parties was a non-cash charge of $6.9 million and a non-cash reduction of expenses of $30.0 million, respectively. No tax benefit has been recognized in connection with this charge. These derivative instruments do not qualify for hedge accounting under ASC 815, Derivatives and Hedging; therefore, changes in the fair values are recognized in earnings in the period of change.
Retail Ventures estimates the fair values of derivatives based on the Black-Scholes Pricing Model using current market rates and records all derivatives on the balance sheet at fair value. The fair market value of the warrants was $20.6 million and $23.1 million at January 29, 2011 and January 30, 2010, respectively. The values ascribed to warrants were estimated using the Black-Scholes Pricing Model with the following assumptions.
13. COMMITMENTS AND CONTINGENCIES
The Company is involved in various 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 Company’s 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 Company’s results of operations and financial condition.
The Company is exposed to a number of asserted and unasserted claims encountered in the course of its business. The Company believes adequate provision has been made for all such asserted and unasserted claims in accordance with accounting principles generally accepted in the United States. Such matters are subject to many uncertainties and outcomes that are not predictable with assurance.
Guarantees and Liabilities related to Discontinued Operations
RVI may become subject to various risks related to guarantees and in certain circumstances may be responsible for certain other liabilities related to discontinued operations. Changes in the amount of guarantees and liabilities related to discontinued operations are included in the loss from discontinued operations on the statements of operations. The reduction in the liability through January 29, 2011 is due to payments by the primary obligor to the guaranteed party or information available indicating that it was no longer probable that the guaranteed liability or other liability would be incurred. Additionally, if the underlying obligations are paid down or otherwise liquidated by the primary obligor, subject to certain statutory requirements, RVI will recognize a reduction of the associated liability. In certain instances, RVI or Retail Ventures Services, Inc. (“RVS”) may have the ability to reduce the estimated potential liability of $0.6 million. The amount of any reduction is not reasonably estimable.
Value City
As discussed above, RVI completed the disposition of an 81% ownership interest in its Value City business segment on January 23, 2008. Retail Ventures or its wholly-owned subsidiary, RVS, has guaranteed and in certain circumstances may be responsible for certain liabilities of Value City. If Value City does not pay creditors whose obligations RVI and RVS had guaranteed, RVI may become subject to various risks associated with such refusal to pay creditors or any insolvency or bankruptcy proceedings.
As of January 29, 2011, RVI had recorded an estimated potential liability of $0.4 million, of which $0.3 million is classified as short-term, for the guarantees of Value City commitments including, but not limited to: amounts of approximately $0.1 million for the guarantee of certain workers compensation claims for events prior to the disposition date and other amounts totaling $0.3 million. As of January 30, 2010, RVI had recorded an estimated liability of $2.9 million, of which $2.4 million is classified as short-term, for the guarantees of Value City commitments described above.
On October 25, 2010, Value City Holdings, Inc., Value City Department Stores LLC, Value City Department Stores Services, Inc., Value City of Michigan, Inc., Gramex Retail Stores, Inc., GB Retailers, Inc., J.S. Overland Delivery, Inc., Retail Ventures Jewelry, Inc., and VCHI Acquisition Co. (collectively, “Debtors”) filed a complaint against RVI, Retail Ventures Services, Inc., and DSW (the “Defendants”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). The complaint relates to Debtors’ pending voluntary cases under Chapter 11 of the Bankruptcy Code.
In the complaint, Debtors have alleged claims for avoidable preferences, fraudulent transfer, receipt of illegal dividends, recovery of assets, unjust enrichment and breach of contract. The claims are related to transfers made by Debtors to the Defendants during the one year period preceding Debtors’ filing of voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code on October 26, 2008. Debtors have sought damages that total approximately $373.4 million.
On January 20, 2011, the Bankruptcy Court approved a settlement between the Debtors and the Defendants, which became final and non-appealable as of February 4, 2011. The Defendants have paid to Value City the settlement payment of $3.6 million and Value City has filed a dismissal of the complaint.
Filene’s Basement
On April 21, 2009, RVI disposed of its Filene’s Basement operations. RVI agreed to indemnify Buxbaum, FB II Acquisition Corp. and their owners against certain liabilities. As of January 29, 2011, RVI had recorded a liability of $0.2 million for the guarantees of Filene’s Basement commitments related to leases not assumed by New Filene’s Basement.
Contractual Obligations
As of January 29, 2011, DSW 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. DSW’s obligations under these commitments aggregated to approximately $3.4 million as of January 29, 2011. In addition, as of January 29, 2011, DSW has signed nine lease agreements for new store locations opening in fiscal 2011 and fiscal 2012 with total annual rent of approximately $5.6 million. In connection with the new lease agreements, DSW expects to receive a total of approximately $5.3 million of construction and tenant allowances, which reimburses DSW for expenditures at these locations.
14. INCOME TAXES
The income tax expense (benefit) for continuing operations consists of the following (in thousands):
A reconciliation of the expected income taxes for continuing operations based upon the statutory rate is as follows (in thousands):
The components of the net deferred tax asset are (in thousands):
The net deferred tax asset recorded in the Company’s consolidated balance sheet is as follows (in thousands):
The Company establishes valuation allowances for deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. The Company recorded a decrease to the valuation allowance of $2.4 million for fiscal 2010. The Company recorded an increase to the valuation allowance, which includes amounts related to assets held for sale at January 31, 2009, of $41.1 million for fiscal 2009. The ending balances of the valuation allowance at January 29, 2011 and January 30, 2010, were $89.4 million and $91.8 million, respectively. The Company believes it is more likely than not that the remaining deferred tax assets will be realized.
The net operating loss deferred tax asset consists of a federal and state component. At January 29, 2011, the federal component is $128.3 million and the state component is $20.2 million. These net operating losses are available to reduce federal and state taxable income for the fiscal years 2011 to 2031.
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 expense in its condensed consolidated statement of income. As of January 29, 2011 and January 30, 2010, $0.3 million and $1.9 million, respectively, were accrued for the payment of interest and penalties.
As of January 29, 2011, January 30, 2010 and January 31, 2009, unrecognized tax benefits of $0.9 million, $0.8 million and $0.9 million, respectively, of the total unrecognized tax benefits of $2.9 million, $9.0 million and $1.3 million, respectively, would affect the Company’s effective tax rate if recognized. The following table presents the reconciliation of the beginning and ending amount of unrecognized tax benefits as of the periods presented:
While it is expected that the amount of unrecognized tax benefits will change in the next 12 months, any change is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
The Company is no longer subject to U.S. federal income tax examinations for years prior to 2007. In general, the Company is no longer subject to state tax examination for fiscal years prior to 2007. The Company estimates the range of possible changes that may result from any current and future tax examinations to be insignificant at this time.
15. SEGMENT REPORTING
The Company is operated in two segments: DSW and Corporate. All of the operations are located in the United States. As a result of RVI’s disposition of Filene’s Basement during fiscal 2009, the results of Filene’s Basement operations are included in discontinued operation and Filene’s Basement is therefore no longer included as a reportable segment of the Company. As a result of RVI’s disposition of an 81% ownership interest in its Value City business during fiscal 2007, the results of the Value City operations are also included in discontinued operations and Value City is therefore no longer included as a reportable segment of the Company.
The Company has identified its segments based on chief operating decision maker responsibilities and measures segment profit (loss) as operating profit (loss), which is defined as profit (loss) before interest expense, income taxes and noncontrolling interest. The goodwill balance of $25.9 million outstanding at January 29, 2011 and January 30, 2010, is recorded in the DSW segment. The Corporate segment includes activities that are not allocated to the DSW segment. Capital expenditures in brackets represent assets transferred to other segments.
The following table sets forth the approximate percentage of the consolidated sales attributable to each merchandise category for the fiscal years below:
The tables below present segment statement of operations information (in thousands):
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
In the Company’s opinion, the unaudited quarterly information reflects all normal and recurring accruals and adjustments necessary for a fair presentation of the Company’s net income (loss) for interim periods. Quarterly results are not necessarily indicative of a full year’s operations because of various factors. The Company’s unaudited quarterly financial information is as follows (in thousands except per share data):
(1)
(Loss) earnings per share calculations for each quarter are based on the applicable weighted average shares outstanding for each period and may not necessarily be equal to the full year per share amount
(1)
(Loss) earnings per share calculations for each quarter are based on the applicable weighted average shares outstanding for each period and may not necessarily be equal to the full year per share amount
17. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION (in thousands)
18. SUBSEQUENT EVENTS
Merger Agreement
On February 8, 2011, RVI, DSW, and DSW MS LLC, a wholly owned subsidiary of DSW (“DSW Merger LLC”) entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which RVI will merge with and into DSW Merger LLC, with DSW Merger LLC continuing as the surviving corporation and a wholly-owned subsidiary of DSW (the “Merger”). RVI’s board of directors and the independent members of DSW’s board of directors have approved the Merger Agreement based on the recommendation of a special committee of each board of directors and have recommended that the shareholders of Retail Ventures and DSW, respectively, adopt the Merger Agreement and the Merger.
Upon the closing of the Merger, each outstanding RVI common share will be converted into the right to receive 0.435 DSW Class A Common Shares, unless the holder properly and timely elects to receive a like amount of DSW Class B Common Shares in lieu of DSW Class A Common Shares. All compensatory awards based on or comprised of RVI Common Shares, such as stock options, stock appreciation rights, and restricted stock, will be converted into and become, respectively, awards based on or comprised of DSW Class A Common Shares, in each case on terms substantially identical to those in effect immediately prior to the effective time of the Merger, in accordance with the 0.435 exchange ratio.
It is expected that the Merger will qualify as a tax-free reorganization for U.S. federal income tax purposes, so that, in general, none of DSW, RVI, DSW Merger LLC or any of the RVI shareholders will recognize any gain or loss in the transaction, except that RVI shareholders will generally recognize gain or loss with respect to cash received in lieu of fractional shares of DSW Class A or Class B Common Shares.
The Merger Agreement provides that DSW Merger LLC will assume, as of the effective time of the Merger, by supplemental indenture and supplemental agreement, all of RVI’s obligations with respect to certain 6.625% mandatorily exchangeable notes due September 15, 2011, known as Premium Income Exchangeable Securities or PIES, and will assume by operation of law the warrants issued by RVI to purchase DSW Class A Common Shares outstanding immediately prior to the effective time of the Merger.
Upon the closing of the Merger, one of RVI’s current board members will be appointed to DSW’s board of directors.
The parties have made customary representations and warranties and agreed to customary covenants in the Merger Agreement. The transaction is not subject to any financing condition. The completion of the Merger is conditioned upon, among other things:
•
adoption of the Merger Agreement and the Merger by (i) the holders of a majority of the outstanding DSW Class A Common Shares and Class B Common Shares, voting together as a class, (ii) the holders of a majority of the unaffiliated DSW Class A Common Shares (i.e., those holders other than RVI, Schottenstein Stores Corporation (“SSC”), which controls a majority of the voting power of RVI, and their respective affiliates), voting together as a class, and (iii) the holders of a majority of outstanding RVI Common Shares;
•
adoption of amended and restated articles of incorporation of DSW, which will amend the current articles of incorporation to allow holders of Class B Common Shares to convert such shares into Class A Common Shares, among other amendments, by (i) the holders of a majority of the DSW Class A Common Shares and DSW Class B Common Shares, voting together as a class, and (ii) the holders of a majority of the DSW Class A Common Shares, voting as a separate class; and
•
approval of the issuance of DSW Class A Common Shares and Class B Common Shares to RVI shareholders by the holders of a majority of the DSW Class A Common Shares and DSW Class B Common Shares, voting together as a class.
In addition, DSW and RVI have agreed not to initiate, solicit, encourage, or knowingly facilitate the making of any proposal or offer with respect to certain specified acquisition proposals. The Merger Agreement may be terminated by DSW and RVI under certain circumstances, including by DSW or RVI if, among other requirements, the terminating party has received certain specified superior proposals, has not violated its obligations under the Merger Agreement with respect to any superior proposal, and pays an amount equal to the reasonably documented transaction expenses of the other party, not to exceed $10 million.
The pending transaction between DSW and Retail Ventures will be accounted for as a reverse merger with Retail Ventures as the accounting acquirer and DSW as the accounting acquiree (which is the surviving entity for legal purposes). As this is a common control transaction under Accounting Standard Codification (“ASC”) 805, Business Combinations, the transaction will be accounted for as an equity transaction in accordance with ASC 810, Consolidation as the acquisition of a noncontrolling interest and will not require purchase accounting. Legally, Retail Ventures will merge into a subsidiary of DSW. For financial reporting purposes, the transaction will be accounted for as if Retail Ventures acquired the outstanding noncontrolling interest in DSW. Furthermore, because Retail Ventures will be treated as the continuing reporting entity for accounting purposes, the reports filed by DSW, as the surviving corporation in the transaction, after the date of the transaction will be prepared as if Retail Ventures were the legal successor to its reporting obligation as of the date of the transaction. Accordingly, prior period financial information presented in the DSW consolidated financial statements will reflect certain historical activity of Retail Ventures.
Litigation Relating to the Proposed Merger
Purported shareholders of RVI have filed two putative shareholder class action lawsuits in an Ohio state court against RVI and its directors and in one case, its chief executive officer (referred to, collectively, as the RVI defendants), and DSW and in one case DSW Merger LLC (referred to collectively as the DSW defendants). The lawsuits allege, among other things, that RVI and its directors breached their fiduciary duties by approving the Merger Agreement, and that in one case RVI’s chief executive officer and DSW, and in the other that RVI and DSW aided and abetted in these alleged breaches of fiduciary duty. The complaints seek, among other things, to enjoin the shareholder vote on the Merger, as well as monetary damages. The RVI defendants and the DSW defendants intend to defend vigorously against these claims.
Loan Agreement
On February 8, 2011, RVI and SEI, Inc. (“SEI”) entered into a Loan Agreement (the “Loan Agreement”) pursuant to which SEI has made available to RVI a revolving credit facility in the principal amount not to exceed $30,000,000 (the “Credit Facility”). The Credit Facility is subject to the terms and conditions set forth in: (1) the Loan Agreement and (2) a Note, dated February 8, 2011, payable by RVI to the order of SEI in the principal amount of $30,000,000 (the “Note” and, together with the Loan Agreement, the “Loan Documents”). Pursuant to the terms and conditions of the Loan Documents, SEI will advance funds to RVI, and RVI will use the funds to provide for its ongoing working capital and general corporate needs. Upon execution of the Loan Agreement, RVI also paid an up-front commitment fee of 8.75% of the maximum loan amount (or $2,625,000) to SEI.
The initial principal amount of the Credit Facility is $30,000,000, and will be repaid in accordance with the terms of the Loan Documents. Each draw under the Credit Facility must be for a minimum amount of $5 million. Interest under the Credit Facility will accrue at LIBOR plus 5.00%, or, upon the occurrence of an Event of Default (as described below), LIBOR plus 7.00%. All outstanding principal and accrued but unpaid interest under the Credit Facility is due and payable in full on the earlier of either February 8, 2013 or two days after the closing of the Merger (the “Revolving Credit Expiration Date”). The Credit Facility contains customary representations, covenants and events of default, and also specifies that an Event of Default includes where the closing per share market price of the common shares owned by RVI in DSW traded on the New York Stock Exchange is less than $20.00 for a period of five (5) or more consecutive business days or for any five (5) business days within any period of ten (10) consecutive business days.
Upon an Event of Default (as that term is defined in the Loan Agreement), the interest rate will increase to LIBOR plus 7.00% and SEI may elect to: (1) terminate the Credit Facility; (2) declare immediately due and payable in cash the entire outstanding principal balance, together with all accrued but unpaid interest, and any and all other amounts due and owing; and (3) exercise any and all rights and remedies available to SEI pursuant to the Loan Documents or under applicable law.
Rights Agreement
On February 7, 2011, the board of directors of RVI authorized and declared a dividend distribution of one Right for each outstanding RVI common share to stockholders of record at the close of business on February 24, 2011 (the “Record Date”). Each Right entitles the registered holder to purchase from RVI a unit (a “Unit”) consisting of a number of RVI Common Shares at a Purchase Price of $80.00 per Unit, subject to adjustment. The description and terms of the Rights are set forth in a Rights Agreement (the “Rights Agreement”) between RVI and Computershare Trust Company, N.A., a federally chartered trust company, as Rights Agent.
The Rights Agreement is intended to help protect RVI’s tax net operating losses and certain other tax assets (“Tax Benefits”) by deterring any person (other than RVI, any subsidiary of RVI or any employee benefit plan of RVI) from becoming a 5% Shareholder (as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”)) without the approval of the board of directors (any such person who becomes a 5% Shareholder, other than as described below, an “Acquiring Person”). Notwithstanding the foregoing, shareholders who own 5% or more (by value) of outstanding (i) common shares of RVI, (ii) preferred shares (other than preferred shares described in Section 1504(a)(4) of the Code) of RVI, (iii) warrants, rights, or options (including options within the meaning of Section 1.382-4(d)(9) of the Treasury Regulations) to purchase common shares (other than preferred shares described in Section 1504(a)(4) of the Code) of RVI, and (iv) any other interest that would be treated as “stock” of RVI pursuant to Section 1.382-2T(f)(18) of the Treasury Regulations, “Company Securities”) as of the close of business on February 8, 2011, and shareholders who acquire such an interest solely as a result of (A) a transaction in which such shareholder received the approval of the Board of Directors or (B) an issuance by RVI that was approved by the Board of Directors will not be an Acquiring Person and therefore will not trigger the Rights Plan, so long as they do not acquire any additional Company Securities, or decrease their percentage ownership of Company Securities below 5% and subsequently become a 5% Shareholder.
Initially, the Rights will be attached to all common share certificates representing shares then outstanding, and no separate Rights Certificates will be distributed. Subject to certain exceptions specified in the Rights Agreement, the Rights will separate from the common shares and a Distribution Date will occur upon the earlier of (i) the close of business on the tenth business day following the date of public announcement that a person has become an Acquiring Person other than by reason of a transaction approved by the Board of Directors or (ii) the close of business on the tenth business day (or such later date as the Board of Directors shall determine prior to the time a person becomes an Acquiring Person) following the commencement of a tender offer or exchange offer that would result in a person or group becoming an Acquiring Person (the earlier of the dates in clause (i) or (ii) above being called the “Distribution Date”), provided, however, the Distribution Date shall not occur if the Board of Directors shall have affirmatively determined that, in light of the intent and purposes of this Rights Agreement or other circumstances facing RVI, a Distribution Date shall not be deemed to have occurred.
The definition of Acquiring Person contained in the Rights Agreement contains several exemptions, including for (i) RVI or any of its subsidiaries; (ii) any employee benefit plan of RVI, or of any subsidiary of RVI, or any person or entity organized, appointed or established by RVI for or pursuant to the terms of any such plan; and (iii) the U.S. Government.
The Rights are not exercisable until the Distribution Date and will expire at 5:00 P.M. (New York City time) on September 15, 2011 unless such date is advanced or extended or the Rights are earlier redeemed or exchanged by RVI as described below.
In the event that a person becomes an Acquiring Person, each holder of a Right will thereafter have the right to receive, upon exercise, common shares (or, in certain circumstances, cash, property or other securities of RVI) having a value equal to two times the exercise price of the Right. Notwithstanding any of the foregoing, following the occurrence of the event set forth in this paragraph, all Rights that are, or (under certain circumstances specified in the Rights Agreement) were, beneficially owned by any Acquiring Person will be null and void. However, Rights are not exercisable following the occurrence of the event set forth above until such time as the Rights are no longer redeemable by RVI as set forth below.
In the event that, at any time after a person becomes an Acquiring Person, (i) RVI engages in a merger or other business combination transaction (other than a merger or other business combination transaction with a subsidiary of RVI) in which RVI is not the surviving corporation, (ii) RVI engages in a merger or other business combination transaction in which RVI is the surviving corporation and the Common Stock of RVI is changed or exchanged, or (iii) 50% or more of RVI’s assets, cash flow or earning power is sold or transferred, each holder of a Right (except Rights which have previously been voided as set forth above) shall thereafter have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the Right. The events set forth in this paragraph and in the second preceding paragraph are referred to as the “Triggering Events.”
At any time after a person becomes an Acquiring Person and prior to the acquisition by an Acquiring Person of 50% or more of the then outstanding shares of Common Stock, the board of directors may exchange the Rights (other than Rights owned by such person or group which have become void), in whole or in part, at an exchange ratio of one common share per Right (subject to adjustment).
Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of RVI, including, without limitation, the right to vote or to receive dividends. While the distribution of the Rights will not be taxable to stockholders or to RVI, stockholders may, depending upon the circumstances, recognize taxable income in the event that the Rights become exercisable for common shares (or other consideration) of RVI or for common shares of the acquiring company or in the event of the redemption of the Rights as set forth above.
SCHEDULE I
RETAIL VENTURES, INC. (Parent Company Only)
CONDENSED BALANCE SHEETS
January 29, 2011 and January 30, 2010
(in thousands)
S-1
SCHEDULE I
RETAIL VENTURES, INC. (Parent Company Only)
CONDENSED BALANCE SHEETS (Continued)
January 29, 2011 and January 30, 2010
(in thousands)
S-2
SCHEDULE I
RETAIL VENTURES, INC. (Parent Company Only)
CONDENSED STATEMENTS OF OPERATIONS
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
S-3
SCHEDULE I
RETAIL VENTURES, INC. (Parent Company Only)
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
S-4
SCHEDULE I
RETAIL VENTURES, INC. (Parent Company Only)
CONDENSED STATEMENTS OF CASH FLOWS (Continued)
Years Ended January 29, 2011, January 30, 2010 and January 31, 2009
(in thousands)
S-5
INDEX TO EXHIBITS
E-1
E-2
E-3
E-4
E-5
*
Filed herewith.
**
Exhibits and schedules omitted pursuant to Item 601(b)(2) of Regulation S-K. Retail Ventures agrees to furnish a supplemental copy of an omitted exhibit or schedule to the SEC upon request.
#
Management contract or compensatory plan or arrangement.
E-6