DSW Inc (DSW) SEC Quarterly Report (10-Q) for Q3 2017

Washington, D.C. 20549

(Mark One)

For the quarterly period ended July 29, 2017

or

Commission file number 1-32545

Registrant's telephone number, including area code: (614) 237-7100

Number of shares outstanding of each of the registrant's classes of common stock, as of August 18, 2017 : 72,616,519 Class A Common Shares and 7,732,786 Class B Common Shares.

DSW INC.

TABLE OF CONTENTS

All references to "we," "us," "our," "DSW Inc.," or the "Company" in this Quarterly Report on Form 10-Q mean DSW Inc. and its wholly-owned subsidiaries. DSW refers to the DSW segment, which includes DSW stores and dsw.com. We own many trademarks and service marks. This Quarterly Report on Form 10-Q may contain trademarks, trade dress, and tradenames of other companies. Use or display of other parties' trademarks, trade dress or tradenames is not intended to and does not imply a relationship with the trademark, trade dress or tradename owner.

DSW INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited and in thousands, except per share amounts)

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

DSW INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited and in thousands)

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

DSW INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited and in thousands)

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

DSW INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)

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

1 .    BUSINESS OPERATIONS AND BASIS OF PRESENTATION

Business Operations- DSW Inc., an Ohio corporation, together with its wholly-owned subsidiaries, is the destination for fabulous footwear brands and accessories at a great value every single day. We offer a wide assortment of brand name dress, casual and athletic footwear and accessories for women, men and kids. We conduct business in two reportable segments: the DSW segment ("DSW"), which includes DSW stores and dsw.com, and the Affiliated Business Group ("ABG") segment.

The ABG segment partners with three other retailers to help build and optimize their in-store and online footwear businesses. ABG supplies merchandise for the shoe departments of Stein Mart, Gordmans, and Frugal Fannie's. On March 13, 2017 , Gordmans filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code and announced its plan to liquidate inventory and other assets. Stage Stores, Inc. acquired 58 of the Gordmans' stores and we have signed an agreement to provide services for these stores through the end of fiscal 2017.

We also have an equity investment in Town Shoes Limited ("Town Shoes"). Town Shoes is the market leader in Canada for the sale of branded footwear offered in stores and on e-commerce sites under the banners of The Shoe Company, Shoe Warehouse, Town Shoes and DSW.

During fiscal 2016, we completed several transactions that supported our efforts to grow market share within footwear and accessories domestically and internationally. On March 4, 2016 , we acquired Ebuys, Inc. ("Ebuys"), a leading off price footwear and accessories retailer operating in digital marketplaces. Ebuys sells products to customers located in North America, Europe, Australia and Asia. On August 2, 2016, we signed an agreement with the Apparel Group as an exclusive franchise partner in the Gulf Coast region of the Middle East. Under this franchise agreement, the first franchise store opened during the second quarter of fiscal 2017, and we plan to expand the DSW banner by up to 40 stores across the territory.

Basis of Presentation- The accompanying unaudited, condensed consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, we do not include all of the information and footnotes required by GAAP for complete financial statements. The accompanying financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. All such adjustments are of a normal recurring nature. The condensed consolidated financial position, results of operations and cash flows for these interim periods are not necessarily indicative of the results that may be expected in future periods. The balance sheet at January 28, 2017 has been derived from the audited financial statements at that date. The financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017 , filed with the U.S. Securities and Exchange Commission on March 23, 2017.

Fiscal Year- Our fiscal year ends on the Saturday nearest to January 31. References to a fiscal year refer to the calendar year in which the fiscal year begins.

2.    ACQUISITION AND EQUITY INVESTMENT

Acquisition of Ebuys- On March 4, 2016 , we acquired 100% ownership of Ebuys for cash and future amounts to be paid to the sellers of Ebuys contingent upon achievement of certain milestones. During fiscal 2016 , we had purchase price adjustments based on working capital adjustments and measurement period adjustments of the contingent consideration liability, based on additional information about facts and circumstances that existed at the acquisition date that were obtained after that date. We also made various measurement period adjustments for the assets and liabilities acquired.

The preliminary and final purchase price and the allocation of the total consideration to the fair values of the assets and liabilities acquired consisted of the following:

The final fair value of intangible assets includes $22.3 million for online retailer and customer relationships based on using the excess earnings method, $11.0 million for tradenames based on using the relief from royalty method, and $5.4 million for non-compete agreements based on using the with-and-without method. The categorization of the fair value framework used for these methods are considered Level 3 due to the subjective nature of the unobservable inputs used to determine the fair value.

The goodwill represents the intangible assets that do not qualify for separate recognition and is primarily the result of expected synergies, vertical integration as a market for selling aged inventory, online presence, and the acquired workforce. Goodwill related to this acquisition is deductible for income tax purposes.

During fiscal 2016 and 2017, we also made adjustments to the contingent consideration liability based on Ebuys' results of operations and revised projections for the contingent periods and accretion in value. These adjustments were not considered measurement period adjustments and were recognized as an adjustment to income from operations.

Equity Investment in Town Shoes- In May 2014, we acquired a 49.2% interest in Town Shoes for $75.1 million Canadian dollars ("CAD") ( $68.9 million United States dollars ("USD")), which included the purchase of an unsecured subordinated note from Town Shoes issued on February 14, 2012 that earns payment-in-kind interest at 12% and matures on February 14, 2022. As of July 29, 2017 , our ownership percentage was 46.3% . The dilution of our ownership is due to Town Shoes' employee exercise of stock options. Our ownership stake provides 50% voting control and board representation equal to the co-investor.

Additionally, the Town Shoes co-investor holds a put option to sell the remaining interest in Town Shoes in fiscal 2017 to the Company and for the subsequent two years. We hold a call option to purchase the remaining interest in Town Shoes in fiscal 2018, and for the subsequent two years, if the Town Shoe co-investor has not exercised their put option. During fiscal 2015, we invested $100 million CAD in available-for-sale securities denominated in CAD in anticipation of funding the future purchase of the remaining interest in Town Shoes. As of July 29, 2017 , these available-for-sale securities are classified as short-term investments based on management's intent to exercise the call option to purchase the remaining interest in Town Shoes in the first half of fiscal 2018.

3 .    SIGNIFICANT ACCOUNTING POLICIES

Accounting Policies - The complete summary of significant accounting policies is included in the notes to the consolidated financial statements as presented in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017 .

Principles of Consolidation- The consolidated financial statements include the accounts of DSW Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. All amounts are in USD, unless otherwise noted.

Use of Estimates- The preparation of financial statements in conformity with GAAP 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 sales returns, depreciation, amortization, inventory valuation, contingent consideration liability, customer loyalty program reserve, recoverability of long-lived assets and intangible assets, legal reserves, accrual for lease obligations 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.

Cash, Cash Equivalents, and Restricted Cash - Cash and cash equivalents represent cash, money market funds and credit card receivables that generally settle within three days. Restricted cash represents cash that is restricted as to withdrawal or usage and consists of a mandatory cash deposit with the lender for outstanding letters of credit.

The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same such amounts shown in the condensed consolidated statements of cash flows:

Fair Value- 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. Assets and liabilities recorded at fair value are categorized using defined hierarchical levels related to the subjectivity associated with the inputs to fair value measurements as follows:

Accumulated Other Comprehensive Income (Loss)- Changes for the balances of each component of accumulated other comprehensive loss were as follows (all amounts are net of tax):

Adopted Accounting Standards- In the first quarter of fiscal 2017, we adopted the Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU") 2016-09, Improvements to Employee Share-Based Payment Accounting , which eliminated the requirement to recognize excess tax benefits in common shares paid-in capital and the requirement to evaluate tax deficiencies for common shares paid-in capital or income tax expense classification, and provides for these benefits or deficiencies to be recorded as an income tax expense or benefit on a prospective basis. For the consolidated statements of cash flows, excess tax benefits related to stock-based compensation is no longer presented, on a retroactive basis, as a financing activity cash inflow and as an operating activity cash outflow. As we did not have any excess tax benefits related to stock-based compensation during the six months ended July 30, 2016 , the adoption of ASU 2016-09 did not result in a change in the activity presented in the statements of cash flows.

In the first quarter of fiscal 2017, we early adopted ASU 2016-18, Statement of Cash Flows - Restricted Cash, which requires that the consolidated statements of cash flows provides the change in the total of cash, cash equivalents, and restricted cash. As a result of this adoption, we no longer show the changes in restricted cash balances as a component of cash flows from investing activities but instead include the balances of restricted cash together with cash and cash equivalents for the beginning and end of the periods presented.

As a result of adopting ASU 2016-18, we adjusted the statements of cash flows on a retroactive basis as follows:

Recent Accounting Pronouncements- In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers , which provides a single comprehensive accounting standard for revenue recognition for contracts with customers and supersedes current guidance. Under ASU 2014-09, companies will recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the payment to which a company expects to be entitled in exchange for those goods or services. The standard also will require enhanced disclosures and provide more comprehensive guidance for transactions such as service revenue and contract modifications. The standard is effective for us in the first quarter of fiscal 2018, which we plan to adopt using the full retrospective method where each prior period presented is restated. We have completed an assessment identifying areas of impact to our financial statements, including sales returns, licensing arrangements, gift cards, and our loyalty and co-branded credit card programs. The adoption of the new standard will result in changes in classification between net sales, other revenues, cost of sales, and operating expenses. For income from breakage of gift cards, which is currently recognized as a reduction to operating expenses when the redemption of the gift card is deemed remote, the new standard will require classification within net sales recognized proportionately over the expected redemption period. Also upon adoption of the standard, we will no longer use the incremental cost method and record to cost of sales for our loyalty program, rather we will use a deferred revenue model. We do not expect the adoption of ASU 2014-09 will have a material impact to our reported net sales, operating profit, net income, shareholders' equity or cash flows, with the primary impacts of adopting the new standard relating to changes in classification of amounts shown on the consolidated financial statements and additional disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases , which will change how lessees account for leases. For most leases, a liability will be recorded on the balance sheet based on the present value of future lease obligations with a corresponding right-of-use asset. Primarily for those leases currently classified by us as operating leases, we will recognize a single lease cost on a straight-line basis based on the combined amortization of the lease obligation and the right-of-use asset. Other leases will be required to be accounted for as financing arrangements similar to current accounting for capital leases. Upon transition, we will recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The standard is effective for us in the first quarter of fiscal 2019 with early adoption permitted. We will not early adopt ASU 2016-02 and we expect the standard will have a material impact to our consolidated balance sheets. We are continuing to assess and evaluate the full impact of the standard on our financial statements and we are developing an implementation plan.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Accounting for Goodwill Impairment , which simplifies the subsequent measurement of goodwill by eliminating the requirement to determine the implied fair value of goodwill to measure an impairment of goodwill. Rather, goodwill impairment charges will be calculated as the amount by which a reporting unit's carrying amount exceeds its fair value. The standard is effective for us for our annual or any interim goodwill impairment tests during fiscal 2020 and early adoption is permitted. We intend to early adopt ASU 2017-04 for our annual or any interim goodwill impairment tests during fiscal 2017.

4.    RELATED PARTY TRANSACTIONS

Accounts receivable, accounts payable, and prepaid expenses associated with related parties are separately presented on the consolidated balance sheets. Accounts receivable from and payables to related parties normally settle in the form of cash in 30 to 60 days.

Schottenstein Affiliates

As of July 29, 2017 , the Schottenstein Affiliates, entities owned or controlled by Jay L. Schottenstein, the executive chairman of our Board of Directors, and members of his family, beneficially owned approximately 19% of the Company's outstanding Common Shares, representing approximately 51% of the combined voting power. As of July 29, 2017 , the Schottenstein Affiliates beneficially owned 7.3 million Class A Common Shares and 7.7 million Class B Common Shares.

Leases with Related Parties- We lease our fulfillment center and certain store locations owned by Schottenstein Affiliates. During the three months ended July 29, 2017 and July 30, 2016 , we recorded rent expense from leases with Schottenstein Affiliates of $2.3 million and $2.0 million , respectively. During the six months ended July 29, 2017 and July 30, 2016 , we recorded rent expense from leases with Schottenstein Affiliates of $4.6 million and $4.1 million , respectively.

Basis Difference Related to Acquisition of Commonly Controlled Entity- The basis difference related to acquisition of commonly controlled entity balance, as shown on our consolidated balance sheets, relates to a legal entity acquisition in fiscal 2012 from certain Schottenstein Affiliates. The legal entity owned property that was previously leased by us. As this was a transaction between entities under common control, there was no adjustment to the historical cost carrying amounts of assets transferred to the Company. The difference between the historical cost carrying amounts and the consideration transferred was reflected as an equity transaction.

Other Purchases and Services- During the three months ended July 29, 2017 and July 30, 2016 , we had other purchases and services from Schottenstein Affiliates of $0.4 million and $0.3 million , respectively. During the six months ended July 29, 2017 and July 30, 2016 , we had other purchases and services from Schottenstein Affiliates of $0.7 million and $0.6 million , respectively.

Town Shoes

Our ownership percentage in Town Shoes is 46.3% , which provides us a 50% voting control and board representation equal to the co-investor, and is treated as an equity investment.

Management Agreement- We have a management agreement with Town Shoes under which we provide certain information technology and management services. During the three and six months ended July 29, 2017 , we recognized income of $0.3 million and $0.6 million , respectively. During the three and six months ended July 30, 2016 , no services were provided.

License Agreement- We license the use of our tradename and trademark, DSW Designer Shoe Warehouse, to Town Shoes for a royalty fee based on a percentage of net sales from its Canadian DSW stores, which are included in net sales. The license is exclusive and non-transferable for use in Canada. During the three months ended July 29, 2017 and July 30, 2016 , we recognized royalty income of $0.2 million and $0.1 million , respectively. During the six months ended July 29, 2017 and July 30, 2016 , we recognized royalty income of $0.3 million and $0.2 million , respectively.

Other Purchases and Services- During the three and six months ended July 29, 2017 , Town had other purchases and services from us of $0.7 million and $1.6 million , respectively. During the three and six months ended July 30, 2016 , no other purchases and services were provided.

David Duong, CEO of Ebuys

On March 4, 2016 , we acquired 100% ownership of Ebuys from its co-founders, including David Duong, who continues to serve on the board of directors of Ebuys, for cash and future amounts to be paid to the co-founders contingent upon achievement of certain milestones. See Note 13 , Commitments and Contingencies , for the estimated fair value of the contingent consideration liability and changes recognized. Mr. Duong will receive 50% of any future payments of the contingent consideration.

5.    EARNINGS PER SHARE

Basic earnings per share is based on net income and the weighted average of Class A and Class B Common Shares outstanding. Diluted earnings per share reflects the potential dilution of common shares adjusted for outstanding stock options, restricted stock units ("RSUs"), performance-based restricted stock units ("PSUs"), and director stock units ("DSUs") calculated using the treasury stock method.

The following is a reconciliation of the number of shares used in the calculation of earnings per share:

For the three months ended July 29, 2017 and July 30, 2016 , the number of potential shares that were not included in the computation of dilutive earnings per share because the effect would be anti-dilutive was approximately 4.6 million and 3.6 million , respectively. For the six months ended July 29, 2017 and July 30, 2016 , the number of potential shares that were not included in the computation of dilutive earnings per share because the effect would be anti-dilutive was approximately 4.3 million and 3.3 million , respectively.

6.    STOCK-BASED COMPENSATION

The fair value for stock option awards was estimated at the grant date using the Black-Scholes pricing model with the following weighted average assumptions for the options granted:

The following table summarizes the stock-based compensation award activity:

As of July 29, 2017 , 4.7 million shares of Class A Common Shares remain available for future stock-based compensation grants under the 2014 Long-Term Incentive Plan.

7.    INVESTMENTS

We hold available-for-sale investments primarily in bonds and term notes. Investments consisted of the following:

8.    FAIR VALUE MEASUREMENTS

Financial Assets and Liabilities- Financial assets and liabilities measured at fair value on a recurring basis consisted of the following:

The short-term and long-term investments categorized as Level 2 were valued using a market-based approach using inputs such as prices of similar assets in active markets. See Note  13 ,  Commitments and Contingencies , for the estimated fair value (categorized as Level 3) of the contingent consideration liability and changes recognized.

We have financial assets and liabilities not required to be measured at fair value on a recurring basis, which primarily consist of accounts receivables, note receivable from Town Shoes, and accounts payables. The carrying value of accounts receivables and accounts payables approximated their fair values due to their short-term nature. As of  July 29, 2017 , January 28, 2017 and July 30, 2016 , the fair value of the note receivable from Town Shoes was  $52.5 million , $45.7 million and $43.6 million , respectively, compared to the carrying value of  $60.1 million , $53.1 million and $50.2 million , respectively. We estimated the fair value of the note receivable based upon current interest rates offered on similar instruments. The change in fair value is based on the change in comparable rates on similar instruments. Based on our intention and ability to hold the note until maturity or the exercise of the put/call option, the carrying value is not other-than-temporarily impaired.

9.    PROPERTY AND EQUIPMENT, NET

Property and equipment consisted of the following:

10.    ACCRUED EXPENSES

Accrued expenses consisted of the following:

To better facilitate the processing efficiency of certain vendor payments, during fiscal 2016 we entered into a vendor payment program with a payment processing intermediary. Under the vendor payment program, the intermediary makes regularly-scheduled payments to participating vendors and we, in turn, settle monthly with the intermediary. The net change in the outstanding balance is reflected as a financing activity in the consolidated statements of cash flows.

11.    NON-CURRENT LIABILITIES

Non-current liabilities consisted of the following:

12.    DEBT

Credit Facility - On August 2, 2013 , we entered into a secured revolving credit agreement (the "Credit Facility") that provides revolving credit up to $100 million . The Credit Facility, together with the Letter of Credit Agreement (defined below), amended and restated the prior credit facility, dated June 30, 2010 . The Credit Facility is secured by a lien on substantially all of DSW Inc.'s personal property assets and its subsidiaries, with certain exclusions, and may be used to provide funds for general corporate purposes, to provide for ongoing working capital requirements and to make permitted acquisitions. Revolving credit loans bear interest under the Credit Facility at our 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 Credit Facility), plus 0.5%, (ii) the Lender's prime rate, and (iii) the Daily LIBOR Rate (as defined in the Credit Facility) plus 1.0%, plus in each instance an applicable margin, which is between 1.00 and 1.25, based upon revolving credit availability; or (b) a LIBOR option at a rate equal to the LIBOR Rate (as defined in the Credit Facility), plus an applicable margin based upon our revolving credit availability. In addition, the Credit Facility contains restrictive covenants relating to the management and operation of our business. These covenants, among other things, limit or restrict our ability to grant liens on our assets, limit our ability to incur additional indebtedness, limit our ability to enter into transactions with affiliates and limit our ability to merge or consolidate with another entity. Our Credit Facility allows the payment of dividends by us or our subsidiaries, provided that we meet the minimum cash and investments requirement of $125 million , as defined in the Credit Facility. An additional covenant limits payments for capital expenditures to $200 million in any fiscal year. As of July 29, 2017 , we had no outstanding borrowings under the Credit Facility with availability of $100 million and we were in compliance with all covenants. Interest expense related to the Credit Facility includes fees, such as commitment and line of credit fees.

Letter of Credit Agreement- Also on August 2, 2013 , we entered into a letter of credit agreement (the "Letter of Credit Agreement"). The Letter of Credit Agreement provides for the issuance of letters of credit up to $50 million . The facility for the issuance of letters of credit is secured by a cash collateral account containing cash in an amount equal to 103% of the face amount of any letter of credit extension ( 105% for extensions denominated in foreign currency) and is used for general corporate purposes. The Letter of Credit Agreement requires compliance with conditions precedent that must be satisfied prior to issuing any letter of credit or extension. In addition, the Letter of Credit Agreement contains restrictive covenants relating to the management and operation of our business. These covenants, among other things, limit or restrict our ability to grant liens on our assets, limit our ability to incur additional indebtedness, limit our ability to enter into transactions with affiliates and limit our ability to merge or consolidate with another entity. An event of default may cause the applicable interest rate and fees to increase by 2% per annum. As of July 29, 2017 , we were in compliance with all covenants. As of July 29, 2017 , January 28, 2017 and July 30, 2016 , we had outstanding letters of credit under the Letter of Credit Agreement of $3.6 million , $3.8 million , and $7.9 million , respectively.

13 .    COMMITMENTS AND CONTINGENCIES

Contingent Consideration Liability- The contingent consideration liability resulted from the acquisition of Ebuys and is based on a defined earnings performance measure for fiscal years 2017, 2018 and 2019 with no defined maximum earn-out. The contingent consideration liability is based on our estimated fair value with any differences between the final acquisition-date fair value and the estimated settlement of the obligation, as remeasured each reporting period, being recognized as an adjustment to income from operations.

Activity for the contingent consideration liability was as follows:

Legal Proceedings- We are involved in various legal proceedings that are incidental to the conduct of our business. Although it is not possible to predict with certainty the eventual outcome of any litigation, we believe the amount of any potential liability with respect to current legal proceedings will not be material to the results of operations or financial condition. As additional information becomes available, we will assess any potential liability related to pending litigation and revise the estimates as needed.

Guarantee- As a result of a previous merger, we provided a guarantee for a lease commitment that is scheduled to expire in 2024 of a location that has been leased to a third party. If the third party does not pay the rent or vacates the premise, we may be required to make full rent payments to the landlord.

Contractual Obligations- As of July 29, 2017 , we have 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. Our obligations under these commitments were $0.7 million as of July 29, 2017 . In addition, we have entered into various noncancelable purchase and service agreements. The obligations under these agreements were approximately $13.0 million as of July 29, 2017 .

14.    SEGMENT REPORTING

15.    SUBSEQUENT EVENTS

On August 17, 2017 , the Board of Directors authorized the repurchase of an additional $500 million of DSW Common Shares under our share repurchase program.

On August 22, 2017 , the Board of Directors declared a quarterly cash dividend payment of $0.20 per share for both Class A and Class B Common Shares. The dividend will be paid on September 29, 2017 to shareholders of record at the close of business on September 19, 2017 .

On August 25, 2017 , we entered into a new senior unsecured revolving credit agreement (the "New Credit Facility") with a maturity date of August 25, 2022 that provides a revolving line of credit up to $300 million , with sub-limits for the issuance of up to $50 million in letters of credit, swing loan advances of up to $15 million , and the issuance of up to $75 million in foreign currency revolving loans and letters of credit. The New Credit Facility replaces the Credit Facility and the Letter of Credit Agreement dated August 2, 2013 . The New Credit Facility may be further increased by up to $100 million subject to agreed upon terms and conditions. The New Credit Facility may be used to provide funds for ongoing and seasonal working capital, capital expenditures, dividends and share repurchases, other expenditures, and permitted acquisitions (as defined). The interest rates and fees under the New Credit Facility fluctuate based on our leverage ratio. The New Credit Facility allows us to select our interest rate for each borrowing from multiple interest rate options that are generally derived from the prime rate or LIBOR.

In addition, the New Credit Facility contains financial and other covenants, including, but not limited to, limitations on indebtedness, liens and investments, as well as the maintenance of a leverage ratio not to exceed 3.25:1 and a fixed charge coverage ratio not to be less than 1.75:1 . A violation of any of the covenants could result in a default under the New Credit Facility that would permit the lenders to restrict our ability to further access the New Credit Facility for loans and letters of credit and require the immediate repayment of any outstanding loans under the New Credit Facility. As of August 25, 2017 , we were in compliance with the covenants of the New Credit Facility.

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

Cautionary Statement Regarding Forward-Looking Information for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995

Some of the statements in this Quarterly Report on Form 10-Q contain forward-looking statements which reflect our current views with respect to, among other things, future events and financial performance. Such forward-looking statements can be identified by the use of forward-looking words such as "outlook," "believes," "expects," "potential," "continues," "may," "should," "seeks," "approximately," "predicts," "intends," "plans," "estimates," "anticipates" or the negative version of those words or other comparable words. Any forward-looking statements contained in this Quarterly Report on Form 10-Q are based upon current plans, estimates, expectations and assumptions relating to our operations, results of operations, financial condition, growth strategy and liquidity. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Such forward-looking statements are subject to numerous risks, uncertainties and other factors that may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In addition to those factors described under "Part I, Item 1A. Risk Factors" in our Annual Report on Form 10-K filed on March 23, 2017, some important factors that could cause actual results, performance or achievements to differ materially from those discussed in forward-looking statements include, but are not limited to, the following:

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results, performance or achievements may vary materially from what we have projected. Furthermore, new factors emerge from time to time and it is not possible for management to predict all such factors, nor can management assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

Executive Overview

With our mission to inspire self-expression, we are deepening our customer connection with unique products and meaningful experiences that will define us as the trusted authority for all things footwear. We are focused on differentiating our assortment by growing relevant brands and improving consistency and localization across our fleet. Furthermore, we are putting more product closer to the customer and co-developing technology that will empower associates to better serve our customers.

We are focused on leveraging our warehouse network and accelerating digital demand. With our brick and mortar locations within 20 miles from approximately 70% of our target population, we aim to provide a seamless shopping experience across all channels, with capabilities such as buy online, pickup in store and buy online, ship to store. We are mobilizing inventory across our channels, which increases our assortment breadth and enables us to effectively manage inventory within the enterprise. With our acquisition of Ebuys, we have expanded our presence in the fast-growing digital marketplaces and have started building the infrastructure that will better leverage Ebuys' platform in the coming years.

As of July 29, 2017 , we operated 510 DSW stores, dsw.com and shoe departments in 291 Stein Mart stores and Steinmart.com, 57 Gordmans stores, and one Frugal Fannie's store. On March 13, 2017 , Gordmans filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code and announced its plan to liquidate inventory and other assets. Stage Stores, Inc. acquired 58 of the Gordmans' stores, including one closed store that will be reopened, and we have signed an agreement to provide services for these stores through the end of fiscal 2017. During the six months ended July 29, 2017 , Gordmans closed 49 stores.

Financial Summary

Total net sales increased to $680.4 million for the three months ended July 29, 2017 from $658.9 million for the three months ended July 30, 2016 . The 3.3% increase in total net sales was primarily driven by new store sales and the 0.6% increase in comparable sales (1) , partially offset by the decrease in net sales due to the closure of 49 Gordmans stores.

During the three months ended July 29, 2017 , gross profit as a percentage of net sales was 28.9% , an increase of 50 basis points from 28.4% in the previous year. The increase in the gross profit rate was primarily driven by lower markdowns.

Net income for the three months ended July 29, 2017 was $28.6 million , or $0.35 per diluted share, which included pre-tax charges of $3.2 million , or $0.03 per share, related to the amortization of intangibles and the change in fair value of the contingent consideration liability associated with the acquisition of Ebuys, restructuring costs and foreign exchange losses. Net income for the three months ended July 30, 2016 was $25.0 million , or $0.30 per diluted share, which included pre-tax charges of $6.7 million , or $0.05 per share, related to transaction costs, purchase accounting impacts, change in fair value of the contingent consideration liability associated with the acquisition of Ebuys and restructuring costs.

We have continued making investments in our business that support our long-term growth objectives. On March 4, 2016 , we acquired Ebuys, a leading off price footwear and accessories retailer operating in digital marketplaces, for a total purchase price of $113.1 million . During the six months ended July 29, 2017 , we invested $28.1 million in capital expenditures compared to $51.9 million during the six months ended July 30, 2016 . Our capital expenditures during the first half of fiscal 2017 primarily related to nine new store openings, store remodels and business infrastructure. During fiscal 2017 , we plan to open a total of 15 stores and close two to four stores.

Results of Operations

The following represents components of our consolidated results of operations, expressed as percentages of net sales:

Three and Six Months Ended July 29, 2017 Compared to Three and Six Months Ended July 30, 2016

Net Sales

Net sales for the three months ended July 29, 2017 increased 3.3% compared to the three months ended July 30, 2016 . Net sales for the six months ended July 29, 2017 increased 2.3% compared to the six months ended July 30, 2016 . The following summarizes the change in total net sales from the same period last year:

The following summarizes net sales by segment: