Dillard's - 10-Q quarterly report FY

(Mark One)

OR

For the transition period from __________ to __________.

Commission file number 1-6140

(Exact name of registrant as specified in its charter)

 

1600 CANTRELL ROAD, LITTLE ROCK, ARKANSAS 72201

(Address of principal executive office)

(Zip Code)

 

(501) 376-5200

(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (check one):

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

See notes to consolidated financial statements.

 

See notes to consolidated financial statements.

 

 

 

See notes to consolidated financial statements.

 

The accompanying unaudited consolidated financial statements of Dillard's, Inc. (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, each as promulgated under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and twelve months ended April 29, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending February 3, 2007 due to the seasonal nature of the business. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the fiscal year ended January 28, 2006 filed with the Securities and Exchange Commission on April 3, 2006.

The Company has various stock option plans that provide for the granting of options to purchase shares of Class A Common Stock to certain key employees of the Company. Exercise and vesting terms for options granted under the plans are determined at each grant date. Prior to January 29, 2006, the Company accounted for those plans pursuant to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“Opinion No. 25”) using the intrinsic value method, as permitted by SFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS No. 123”) as amended by SFAS No. 148, “Accounting for Stock Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123”. No compensation expense has been recorded in the consolidated financial statements for the three and twelve month periods ended April 30, 2005 as all options were granted at not less than fair market value on the date of grant. Effective January 29, 2006, the Company adopted Statement No. 123-R, “Share-Based Payment” (“SFAS No. 123-R”), using the modified-prospective transition method. Under this transition method, all forms of share-based payments to employees, including employee stock options, granted prior to but not yet vested as of January 29, 2006 are treated as compensation and recognized in the income statement based on their estimated fair values under the original provisions of SFAS No. 123, and all share-based payments granted on or subsequent to January 29, 2006 are treated as compensation and recognized in the income statement based on their estimated fair values in accordance with the provisions of SFAS No. 123-R. Results for prior periods have not been restated.

Upon adoption of SFAS No. 123-R, the Company elected to continue to value its share-based payment transactions using a Black-Scholes option pricing model, which was previously used by the Company for purposes of preparing the pro forma disclosures under SFAS No. 123. Under the provisions of SFAS No. 123-R, stock-based compensation expense recognized during the period is based on the portion of the share-based payment awards that are ultimately expected to vest. Accordingly, stock-based compensation expense recognized in the first quarter of 2006 has been reduced for estimated forfeitures. SFAS No. 123-R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Compensation expense for stock option awards granted on or after January 29, 2006 will be expensed using a straight-line single option method, which is the same attribution method that was used by the Company for purposes of its pro forma disclosures under SFAS No. 123.

As a result of adopting SFAS No. 123-R, the Company’s income before income taxes and net income for the three and twelve months ended April 29, 2006, are $532,000 and $340,000 lower, respectively, than if it had continued to account for share-based payments under Opinion No. 25. Basic and diluted earnings per share for the three and twelve months ended April 29, 2006 would have increased $0.01 and $0.00, respectively, if the Company had not adopted SFAS No. 123-R, compared to reported basic and diluted earnings per share of $0.77 and $1.80, respectively. At April 29, 2006, there was $564,000 of total unrecognized compensation expense related to non-vested stock options which is expected to be recognized over a period of 2.0 years. In accordance with SFAS No. 123-R, beginning in the first quarter of 2006 the Company has presented excess tax benefits from the exercise of stock-based compensation awards as a financing activity in the consolidated statement of cash flows.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123-R to options granted under the Company’s stock option plans in all periods presented. For purposes of this pro forma disclosure, the value of options is estimated using the Black-Scholes option-pricing model and amortized to expense over the options’ vesting periods.

The fair value of each option grant is estimated on the date of each grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

There were no stock options granted during the three months ended April 29, 2006 and the three and twelve months ended April 25, 2005, respectively. The weighted-average fair value of options granted during the twelve months ended April 29, 2006 was $10.53. The fair values generated by the Black-Scholes model may not be indicative of the future benefit, if any, that may be received by the option holder.

 

The following table summarizes information about stock options outstanding at April 29, 2006:

The intrinsic value of outstanding stock options at April 29, 2006 was $3.9 million. At April 29, 2006, the intrinsic value of exercisable options was $1.9 million.

On November 1, 2004, the Company completed the sale of substantially all of the assets of its private label credit card business to GE Consumer Finance (“GE”). The purchase price of approximately $1.1 billion included the assumption of $400 million of securitization liabilities and the purchase of owned accounts receivable and other assets. Net cash proceeds received by the Company were $688 million. The Company recorded a pretax gain of $83.9 million as a result of the sale. The gain is recorded in Service Charges, Interest and Other Income on the Consolidated Statement of Income and Retained Earnings for the twelve month period ended April 30, 2005.

As part of the transaction, the Company and GE have entered into a long-term marketing and servicing alliance with an initial term of 10 years, with an option to renew. GE will own the accounts and balances generated during the term of the alliance and will provide all key customer service functions supported by ongoing credit marketing efforts.

During the quarter ended April 30, 2005, the Company recorded pretax expense of $0.4 million for asset impairment and store closing charges. This charge relates to a future lease obligation on a store closed during the quarter. There were no impairment charges recorded during the three months ended April 29, 2006.

Following is a summary of the activity in the reserve established for asset impairment and store closing charges for the three months ended April 29, 2006:

Reserve amounts are included in trade accounts payable and accrued expenses and other liabilities.

During the three months ended April 30, 2005, the Company repurchased $15.4 million of its outstanding unsecured notes prior to their maturity dates. Interest rates on the repurchased securities ranged from 7.8% to 7.9% while the maturity dates ranged from 2023 to 2027. A pre-tax loss of $0.5 million recorded within interest expense resulted from the repurchase of the unsecured notes during the three months ended April 30, 2005.

The following table sets forth the computation of basic and diluted earnings per share ("EPS") for the periods indicated (in thousands, except per share data).

Total stock options outstanding were 7,582,456 and 3,778,134 at April 29, 2006 and April 30, 2005, respectively. Of these, options to purchase 6,521,207 and 2,339,500 shares of Class A common stock at prices ranging from $25.74 to $29.99 and $28.19 to $40.22 per share were outstanding at April 29, 2006 and April 30, 2005, respectively, but were not included in the computation of diluted earnings per share because they would be antidilutive.

Accumulated other comprehensive loss only consists of the minimum pension liability, which is calculated annually in the fourth quarter. The following table shows the computation of comprehensive income (in thousands):

On July 29, 2002, a Class Action Complaint (followed on December 13, 2004 by a Second Amended Class Action Complaint) was filed in the United States District Court for the Southern District of Ohio against the Company, the Mercantile Stores Pension Plan (the “Plan”) and the Mercantile Stores Pension Committee (the “Committee”) on behalf of a putative class of former Plan participants. The complaint alleges that certain actions by the Plan and the Committee violated the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), as a result of amendments made to the Plan that allegedly were either improper and/or ineffective and as a result of certain payments made to certain beneficiaries of the Plan that allegedly were improperly calculated and/or discriminatory on account of age. The Second Amended Complaint does not specify any liquidated amount of damages sought and seeks recalculation of certain benefits paid to putative class members. No trial date has been set.

The Company is defending the litigation vigorously and has named the Plan’s actuarial firm as a cross defendant. While it is not feasible to predict or determine the ultimate outcome of the pending litigation, management believes, after consultation with counsel, that its outcome, after consideration of the provisions recorded in the Company’s consolidated financial statements, would not have a material adverse effect upon its consolidated cash flow or financial position. However, it is possible that an adverse outcome could have an adverse effect on the Company’s consolidated net income in a particular quarterly or annual period.

Various legal proceedings in the form of lawsuits and claims, which occur in the normal course of business, are pending against the Company and its subsidiaries. In the opinion of management, disposition of these matters is not expected to materially affect the Company’s financial position, cash flows or results of operations.

The Company is a 50% guarantor on a $54.3 million loan commitment for a joint venture as of April 29, 2006. At April 29, 2006, the joint venture had $46.6 million outstanding on the loan. The loan is collateralized by a mall in Yuma, Arizona with a book value of $55.0 million at April 29, 2006.

 

The Company is a guarantor on a $185 million loan commitment with another joint venture as of April 29, 2006. The Company is a guarantor on up to 50% of the loan balance with the joint venture partner guaranteeing the remaining 50% of the loan balance. A mall currently under construction in Bonita Springs, Florida provides collateral for the loan. The loan had an outstanding balance of $98.5 million as of April 29, 2006.

 

At April 29, 2006, letters of credit totaling $71.4 million were issued under the Company’s $1.2 billion line of credit facility.

 

 

 

The Company has a nonqualified defined benefit plan for certain officers. The plan is noncontributory and provides benefits based on years of service and compensation during employment. Pension expense is determined using various actuarial cost methods to estimate the total benefits ultimately payable to officers and allocates this cost to service periods. The pension plan is unfunded. The actuarial assumptions used to calculate pension costs are reviewed annually. The Company made contributions of $0.9 million during the quarter ended April 29, 2006. The Company expects to make a contribution to the pension plan of approximately $4.1 million for the remainder of fiscal 2006.

 

The components of net periodic benefit costs are as follows (in thousands):

 

 

During the three months ended April 29, 2006, the Company repurchased approximately 133,500 shares of Class A common stock for $3.3 million under its $200 million program, which was authorized by the board of directors in May of 2005. Approximately $111.9 million in share repurchase authorization remained under this open-ended plan at April 29, 2006.

No shares were repurchased during the quarter ended April 30, 2005.

 

Dillard’s, Inc. (the “Company”, “our” or “we”) operates 331 retail department stores in 29 states. Our stores are located in suburban shopping malls and open-air lifestyle centers and offer a broad selection of fashion apparel and home furnishings. We offer an appealing and attractive assortment of merchandise to our customers at a fair price. We seek to enhance our income by maximizing the sale of this merchandise to our customers. We do this by promoting and advertising our merchandise and by making our stores an attractive and convenient place for our customers to shop.

Fundamentally, the Company’s business model is to offer the customer a compelling price/value relationship through the combination of high quality products and services at a competitive price. The Company seeks to deliver a high level of profitability and cash flow. Items of note for the quarter ended April 29, 2006 include the following:

 

 

 

 

 

A summary of guidance on key financial measures for 2006, in conformity with accounting principles generally accepted in the United States of America (“GAAP”), is shown below. See “forward-looking information” below.

 

The Company’s accounting policies are more fully described in Note 1 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2006. As disclosed in this note, the preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the consolidated financial statements and accompanying notes. Since future events and their effects cannot be determined with absolute certainty, actual results will differ from those estimates. The Company evaluates its estimates and judgments on an ongoing basis and predicates those estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results will differ from these under different assumptions or conditions.

Management of the Company believes the following critical accounting policies significantly affect its judgments and estimates used in preparation of the consolidated financial statements.

Estimates of fair value are primarily determined using projected discounted cash flows and are based on the Company’s best estimate of future revenue and operating costs and general market conditions. These estimates are subject to review and approval by senior management. This approach uses significant assumptions, including projected future cash flows, the discount rate reflecting the risk inherent in future cash flows, and a terminal growth rate.

The following table sets forth the results of operations, expressed as a percentage of net sales, for the periods indicated:

 

 

 

Net sales increased 2% on a total basis and a comparable store basis for the three months ended April 29, 2006 compared to the three months ended April 30, 2005. Sales were strongest in lingerie and accessories, men’s clothing, shoes, decorative home and furniture during the first quarter of 2006, with those areas performing above the Company average trend of a 2% increase for the period. Sales in the other areas were below the average trend for total Company sales performance. Sales were weakest in the children’s category, trending significantly below the average Company performance for the period.

Net sales increased 2% for the twelve months ended April 29, 2006 compared to the same period in 2005. These increases were primarily due to increases in comparable store sales.

 

Comparable store inventory at April 29, 2006 declined 2% compared to April 30, 2005.

 

Advertising, selling, administrative and general expenses ("SG&A expenses") for the three months ended April 29, 2006 decreased $2.7 million compared with April 30, 2005. SG&A expenses, as a percentage of net sales, were 26.9% and 27.6% for the three months ended April 29, 2006 and April 30, 2005, respectively. The percentage decrease in 2006 was driven by expense leverage on the Company’s sales increase and lower advertising costs of $7.9 million partially offset by increases in utilities ($2.6 million), supplies ($1.8 million) and services purchased ($1.7 million).

 

 

Depreciation and amortization expense as a percentage of sales was 4.0% and 4.1% for the three months ended April 29, 2006 and April 30, 2005, respectively. The percentage decrease for the three months ended April 29, 2006 is due to expense leverage and lower equipment depreciation during the first quarter of 2006.

 

 

Rentals, as a percentage of net sales, were 0.6% for the three months ended April 29, 2006 and April 30, 2005, respectively. Rentals increased $1.1 million to $11.6 million for the three months ended April 29, 2006 compared to $10.5 million for the three months ended April 30, 2005. The increase in rentals is due to an increase in leased aircraft and data processing equipment.

 

 

Interest and debt expense for the three months ended April 29, 2006 decreased to $23.6 million or 1.3% of net sales compared to $26.2 million or 1.5% of net sales for the three months ended April 30, 2005. Average debt outstanding declined approximately $149 million during the first quarter of fiscal 2006 compared to the same period in fiscal 2005. The debt reduction was due to normal maturities and repurchases of various outstanding notes.

During the three months ended April 30, 2005, the Company recorded pre-tax expense of $419,000 for asset impairment and store closing costs. This charge relates to a future lease obligation on a store closed during the quarter. There were no impairment charges recorded during the three months ended April 29, 2006.

 

Service charges, interest and other income for the three months ended April 29, 2006 increased to $41.6 million or 2.2% of net sales compared to $35.7 million or 2.0% of net sales for the three months ended April 30, 2005. Income from the marketing and servicing alliance with GE increased $7.0 million to $31.8 million for the three months ended April 29, 2006.

 

 

 

The federal and state income tax rates were 36.4% and 36.0% for the three months ended April 29, 2006 and April 30, 2005, respectively. During the three months ended April 29, 2006, income taxes include a $1 million reduction in reserves for tax contingencies. This change results from resolution of various state income tax issues. Excluding this change, the estimated effective rate for 2006 including the first quarter is 37.4%.

 

 

Net cash flows from operations of $78.6 million for the three months ended April 29, 2006 were adequate to fund the Company’s operations for the period. Cash flows from operations increased slightly from 2005 levels due primarily to a $90.0 million decrease related to changes in accounts payable in the current year compared with the prior year offset by a $73.4 million increase related to changes in inventory in the current year compared to the prior year and an increase in net income of $23.3 million for 2006.

For the three months ended April 29, 2006, the Company recorded a gain on the sale of property and equipment of $1.5 million and received proceeds of $1.5 million.

 

Cash used in financing activities for the three months ended April 29, 2006 totaled $6.0 million compared to cash used of $19.7 million for the three months ended April 30, 2005. During the three months ended April 29, 2006 and April 30, 2005, the Company made principal payments on long-term debt and capital leases of $1.6 and $17.0 million, respectively. During the three months ended April 29, 2006, the Company repurchased approximately 133,500 shares of Class A common stock for $3.3 million under its existing share repurchase authorizations.

 

The Company had cash on hand of $302 million as of April 29, 2006. During fiscal 2006, the Company expects to finance its capital expenditures and its working capital requirements including required debt repayments and stock repurchases, if any, from cash on hand and cash flows generated from operations. As part of its overall liquidity management strategy and for peak working capital requirements, the Company has a $1.2 billion credit facility. The Company expects peak funding requirements of approximately $200 million during fiscal 2006. At April 29, 2006, letters of credit totaling $71.4 million were issued under the credit agreement. Availability for borrowings and letter of credit obligations under the credit agreement is limited to 85% of the inventory of certain Company subsidiaries (approximately $1.12 billion at April 29, 2006) leaving unutilized availability under the facility of $1.05 billion. Depending on conditions in the capital markets and other factors, the Company will from time to time consider possible financing transactions, the proceeds of which could be used to refinance current indebtedness or other corporate purposes.

 

 

 

The Company is a member of a class of a settled lawsuit against Visa U.S.A. Inc. (“Visa”) and MasterCard International Incorporated (“MasterCard”). The Visa Check/Mastermoney Antitrust litigation settlement became final on June 1, 2005. The settlement provides $3.05 billion in compensatory relief by Visa and MasterCard to be funded over a fixed period of time to respective Settlement Funds. The Company expects to receive approximately $6.5 million ($4.1 million after tax) as its share of the proceeds from the settlement. The Company believes this settlement represents an indeterminate mix of loss recovery and gain contingency and therefore believes the application of a gain contingency model is the appropriate model to use for the entire amount of expected proceeds. Therefore, the Company decided to exclude the expected settlement proceeds of $6.5 million from recognition in the consolidated financial statements. At the time the settlement is known beyond a reasonable doubt, the Company will record such gain contingency.

 

Three stores remain closed as a result of Hurricane Katrina. These stores are located in the New Orleans area (two stores) and Biloxi, Mississippi. The Company’s Port Arthur, Texas store remains closed as a result of Hurricane Rita. The Company expects these four stores in the Gulf area to remain closed for at least the first half of fiscal year 2006. Property and merchandise losses in the affected stores are covered by insurance. Insurance proceeds related to the hurricanes of $4.6 million were received during the quarter ended April 29, 2006. The Company has received $20 million in additional insurance proceeds subsequent to April 29, 2006. The Company expects additional insurance recoveries during the remainder of fiscal 2006 as construction is completed on damaged stores and a final settlement is reached with the insurance carriers.

The Company has approximately 90 stores along the Gulf and Atlantic coasts that will not be covered by third party insurance but will rather be self-insured for property and merchandise losses related to “named storms” in fiscal 2006. Therefore, repair and replacement costs will be borne by the Company for damage to any of these stores from “named storms” in fiscal 2006. The Company has created early response teams to assess and coordinate clean up efforts should some stores be impacted by storms. The Company has also redesigned certain store features to lessen the impact of storms and has equipment available to assist in the efforts to ready the stores for normal operations.

 

The Company is a guarantor on a $54.3 million loan commitment for a joint venture as of April 29, 2006. At April 29, 2006, the joint venture had $46.6 million outstanding on the loan. The loan is collateralized by a mall in Yuma, Arizona with a book value of $55.0 million at April 29, 2006.

 

The Company is a guarantor on a $185 million loan commitment with another joint venture as of April 29, 2006. The Company is a guarantor on up to 50% of the loan balance with the joint venture partner guaranteeing the remaining 50% of the loan balance. A mall currently under construction in Bonita Springs, Florida provides collateral for the loan. The loan had an outstanding balance of $98.5 million as of April 29, 2006.

 

The Company does not have any additional arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect the Company’s liquidity or the availability of capital resources.

 

 

 

 

 

There have been no material changes in the information set forth under caption “Item 7A-Quantitative and Qualitative Disclosures About Market Risk” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2006.

The Company maintains “disclosure controls and procedures”, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in the Company’s reports, pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding the required disclosures. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of April 29, 2006, the Company carried out an evaluation, with the participation of Company’s management, including William Dillard, II, Chairman of the Board of Directors and Chief Executive Officer (principal executive officer), and James I. Freeman, Senior Vice-President and Chief Financial Officer (principal financial officer), of the effectiveness of the Company’s “disclosure controls and procedures” pursuant to Securities Exchange Act Rule 13a-15. Based on their evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective at the reasonable assurance level. There were no significant changes in the Company’s internal controls over financial reporting that occurred during the quarter ended April 29, 2006 to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

On July 29, 2002, a Class Action Complaint (followed on December 13, 2004 by a Second Amended Class Action Complaint) was filed in the United States District Court for the Southern District of Ohio against the Company, the Mercantile Stores Pension Plan (the “Plan”) and the Mercantile Stores Pension Committee (the “Committee”) on behalf of a putative class of former Plan participants. The complaint alleges that certain actions by the Plan and the Committee violated the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), as a result of amendments made to the Plan that allegedly were either improper and/or ineffective and as a result of certain payments made to certain beneficiaries of the Plan that allegedly were improperly calculated and/or discriminatory on account of age. The Second Amended Complaint does not specify any liquidated amount of damages sought and seeks recalculation of certain benefits paid to putative class members. No trial date has been set.

The Company is defending the litigation vigorously and has named the Plan’s actuarial firm as a cross defendant. While it is not feasible to predict or determine the ultimate outcome of the pending litigation, management believes after consultation with counsel, that its outcome, after consideration of the provisions recorded in the Company’s consolidated financial statements, would not have a material adverse effect upon its consolidated cash flow or financial position. However, it is possible that an adverse outcome could have a material adverse effect on the Company’s consolidated net income in a particular quarterly or annual period.

From time to time, we are involved in other litigation relating to claims arising out of our operations in the normal course of business. Such issues may relate to litigation with customers, employment related lawsuits, class action lawsuits, purported class action lawsuits and actions brought by governmental authorities. As of June 5, 2006, we are not a party to any legal proceedings that, individually or in the aggregate, are reasonably expected to have a material adverse effect on our business, results of operations, financial condition or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our business, results of operations, financial condition or cash flows.

There have been no material changes in the information set forth under caption “Item 1A-Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2006.

 

 

In May 2005, the Company announced that the Board of Directors authorized the repurchase of up to $200 million of its Class A Common Stock. The plan has no expiration date.

Ratio of Earnings to Fixed Charges:

The Company has calculated the ratio of earnings to fixed charges pursuant to Item 503 of Regulation S-K of the Securities and Exchange Act as follows:

Pursuant to the requirements 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.