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DDS > SEC Filings for DDS > Form 10-K on 28-Mar-2013All Recent SEC Filings

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Form 10-K for DILLARDS INC


28-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

EXECUTIVE OVERVIEW

Dillard's, Inc. operates 302 retail department stores spanning 29 states and an Internet store. Our retail stores are located in fashion-oriented shopping malls and open-air centers and offer a broad selection of fashion apparel, cosmetics and home furnishings. We offer an appealing and attractive assortment of merchandise to our customers at a fair price, including national brand merchandise as well as our exclusive brand merchandise. We seek to enhance our income by maximizing the sale of this merchandise to our customers by promoting and advertising our merchandise and by making our stores an attractive and convenient place for our customers to shop.

The Company also operates CDI, a general contractor whose business includes constructing and remodeling stores for the Company, which is a reportable segment separate from our retail operations.

In accordance with the National Retail Federation fiscal reporting calendar, the fiscal 2012 reporting period presented and discussed below ended February 2, 2013 and contained 53 weeks. The fiscal 2011 and 2010 reporting periods presented and discussed below ended January 28, 2012 and January 29, 2011, respectively, and each contained 52 weeks. For comparability purposes, where noted, some of the information discussed below is based upon comparison of the 52 weeks ended February 2, 2013 to the 52 weeks ended February 4, 2012.

Fiscal 2012

Our operating performance continued to improve during fiscal 2012. Retail sales were higher than last year, as we ended the year with our 10th consecutive quarter of comparable store sales increases. Gross margin improved over last year, mainly from progress in the second half of the year, and operating spending was leveraged. We repurchased $185.5 million, or 2.8 million shares, of our Class A Common Stock during the year. Net income was $336.0 million, or $6.87 per share, for the year, and operating cash flow increased $21.6 million over last year, further enabling the Company to return $252.3 million of dividends to our shareholders, including a special dividend of $5.00 per share.

Included in net income for fiscal 2012 are:


an $11.4 million pretax gain ($7.4 million after tax or $0.15 per share) related to the sale of three former retail store locations.


a $1.6 million pretax charge ($1.0 million after tax or $0.02 per share) for asset impairment and store closing charges related to the write-down of a property held for sale and of an operating property.


a $1.7 million income tax benefit ($0.03 per share) due to a reversal of a valuation allowance related to a deferred tax asset consisting of a capital loss carryforward.


an $18.1 million income tax benefit ($0.37 per share) due to a one-time deduction related to dividends paid to the Dillard's, Inc. Investment and Employee Stock Ownership Plan.

Included in net income of $463.9 million ($8.52 per share) for fiscal 2011 are:


a $201.6 million income tax benefit ($3.70 per share) due to a reversal of a valuation allowance related to the amount of the capital loss carryforward used to offset the capital gain income recognized on the taxable transfer of properties to our REIT.


a $44.5 million pretax gain ($28.7 million after tax or $0.53 per share), net of settlement related expenses, related to the settlement of a lawsuit with JDA Software Group for $57.0 million.


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a $4.2 million pretax gain ($2.7 million after tax or $0.05 per share) related to a distribution from a mall joint venture.


a $2.1 million pretax gain ($1.4 million after tax or $0.03 per share) related to the sale of an interest in a mall joint venture.


a $1.3 million pretax gain ($0.9 million after tax or $0.02 per share) related to the sale of two former retail store locations.


a $1.2 million pretax charge ($0.8 million after tax or $0.01 per share) for asset impairment and store closing charges related to the write-down of one property held for sale.

Highlights of fiscal 2012 include:


A comparable store sales increase of 4% over the prior year based on comparable 52-week periods;


Retail operations gross margin improvement of 30 basis points of sales over the prior year. Retail operations gross margin as a percent of sales were 36.1% and 35.8% for fiscal 2012 and fiscal 2011, respectively;


Operating expense leverage of 60 basis points of sales over the prior year. Operating expenses as a percent of sales were 25.4% and 26.0% for fiscal 2012 and fiscal 2011, respectively;


Net income of $336.0 million ($6.87 per share);


Cash flow from operations increase of $21.6 million over the prior year. Operating cash flows were $522.7 million during fiscal 2012 compared to $501.1 million during fiscal 2011;


Repurchase of $185.5 million (or 2.8 million shares) of the Company's Class A Common Stock; and


Payment of $252.3 million in dividends during fiscal 2012 (including a special dividend of $5.00 per share) compared to dividends of $10.0 million paid during fiscal 2011.

As of February 2, 2013, we had working capital of $724.9 million (including cash and cash equivalents of $124.1 million) and $814.8 million of total debt outstanding, with no scheduled maturities until late fiscal 2017. We operated 302 total stores as of February 2, 2013, a decrease of two stores from the same period last year.


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Key Performance Indicators

    We use a number of key indicators of financial condition and operating
performance to evaluate the performance of our business, including the
following:

                                                     Fiscal        Fiscal      Fiscal
                                                      2012          2011        2010
Net sales (in millions)                             $ 6,593.2     $ 6,263.6   $ 6,121.0
Gross profit (in millions)                          $ 2,346.1     $ 2,216.3   $ 2,140.1
Gross profit as a percentage of net sales                35.6 %        35.4 %      35.0 %
Retail gross profit as a percentage of net sales         36.1 %        35.8 %      35.5 %
Selling, general and administrative expenses as a        25.4 %        26.0 %      26.6 %
percentage of net sales
Cash flow from operations (in millions)             $   522.7     $   501.1   $   512.9
Total retail store count at end of period                 302           304         308
Retail sales per square foot                        $     129     $     121   $     116
Retail stores sales trend                                   3 %**         3 %         2 %
Comparable retail store sales trend                         4 %**         4 %         3 %
Comparable retail store inventory trend                    (1 )%          3 %        (2 )%
Retail merchandise inventory turnover                     2.9           2.8         2.8


--------------------------------------------------------------------------------
    **


Based upon the 52 weeks ended February 2, 2013 and 52 weeks ended February 4, 2012

Trends and Uncertainties

Fluctuations in the following key trends and uncertainties may have a material effect on our operating results.


Cash flow-Cash from operating activities is a primary source of liquidity that is adversely affected when the industry faces economic challenges. Furthermore, operating cash flow can be negatively affected when new and existing competitors seek areas of growth to expand their businesses.


Pricing-If our customers do not purchase our merchandise offerings in sufficient quantities, we respond by taking markdowns. If we have to reduce our retail selling prices, the cost of sales on our consolidated statement of income will correspondingly rise, thus reducing our income and cash flow.


Success of brand-The success of our exclusive brand merchandise as well as merchandise we source from national vendors is dependent upon customer fashion preferences and how well we can predict and anticipate trends.


Sourcing-Our store merchandise selection is dependent upon our ability to acquire appealing products from a number of sources. Our ability to attract and retain compelling vendors as well as in-house design talent, the adequacy and stable availability of materials and production facilities from which we source our merchandise and the speed at which we can respond to customer trends and preferences all have a significant impact on our merchandise mix and, thus, our ability to sell merchandise at profitable prices.


Store growth-Our ability to open new stores is dependent upon a number of factors, such as the identification of suitable markets and locations and the availability of shopping developments, especially in a weak economic environment. Store growth can be further hindered by mall attrition and subsequent closure of underperforming properties.


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Seasonality and Inflation

Our business, like many other retailers, is subject to seasonal influences, with a significant portion of sales and income typically realized during the last quarter of our fiscal year due to the holiday season. Because of the seasonality of our business, results from any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.

We do not believe that inflation has had a material effect on our results during the periods presented; however, our business could be affected by such in the future.

2013 Guidance

    A summary of estimates on key financial measures for fiscal 2013 is shown
below.

                                             Fiscal 2013     Fiscal 2012
           (in millions of dollars)           Estimated        Actual
           Depreciation and amortization      $       261     $       260
           Rentals                                     27              35
           Interest and debt expense, net              65              70
           Capital expenditures                       175             137

General

Net sales. Net sales include merchandise sales of comparable and non-comparable stores and revenue recognized on contracts of CDI, the Company's general contracting construction company. Comparable store sales include sales for those stores which were in operation for a full period in both the current month and the corresponding month for the prior year. Comparable store sales exclude the change in the allowance for sales returns. Non-comparable store sales include: sales in the current fiscal year from stores opened during the previous fiscal year before they are considered comparable stores; sales from new stores opened during the current fiscal year; sales in the previous fiscal year for stores closed during the current or previous fiscal year that are no longer considered comparable stores; sales in clearance centers; and changes in the allowance for sales returns.

Service charges and other income. Service charges and other income include income generated through the Alliance with GE. Other income includes rental income, shipping and handling fees, gift card breakage and lease income on leased departments.

Cost of sales. Cost of sales includes the cost of merchandise sold (net of purchase discounts and non-specific margin maintenance allowances), bankcard fees, freight to the distribution centers, employee and promotional discounts, and direct payroll for salon personnel. Cost of sales also includes CDI contract costs, which comprise all direct material and labor costs, subcontract costs and those indirect costs related to contract performance, such as indirect labor, employee benefits and insurance program costs.

Selling, general and administrative expenses. Selling, general and administrative expenses include buying, occupancy, selling, distribution, warehousing, store and corporate expenses (including payroll and employee benefits), insurance, employment taxes, advertising, management information systems, legal and other corporate level expenses. Buying expenses consist of payroll, employee benefits and travel for design, buying and merchandising personnel.

Depreciation and amortization. Depreciation and amortization expenses include depreciation and amortization on property and equipment.

Rentals. Rentals include expenses for store leases, including contingent rent, and data processing and other equipment rentals.


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Interest and debt expense, net. Interest and debt expense includes interest, net of interest income, relating to the Company's unsecured notes, mortgage note, term note, subordinated debentures and borrowings under the Company's credit facility. Interest and debt expense also includes gains and losses on note repurchases, if any, amortization of financing costs and interest on capital lease obligations.

Gain on litigation settlement. Gain on litigation settlement includes the proceeds received, net of related expenses, from the settlement of a lawsuit with JDA Software Group.

Gain on disposal of assets. Gain on disposal of assets includes the net gain or loss on the sale or disposal of property and equipment and the gain on the sale of an interest in a mall joint venture, if any.

Asset impairment and store closing charges. Asset impairment and store closing charges consist of write-downs to fair value of under-performing or held for sale properties and exit costs associated with the closure of certain stores. Exit costs include future rent, taxes and common area maintenance expenses from the time the stores are closed.

Income on (equity in losses of) joint ventures. Income on (equity in losses of) joint ventures includes the Company's portion of the income or loss of the Company's unconsolidated joint ventures as well as a distribution of excess cash from one of the Company's mall joint ventures.

Critical Accounting Policies and Estimates

The Company's significant accounting policies are also described in Note 1 of Notes to Consolidated Financial Statements. As disclosed in that note, the preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions about future events that affect the amounts reported in the consolidated financial statements and accompanying notes. 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. Since future events and their effects cannot be determined with absolute certainty, actual results could differ from those estimates.

Management of the Company believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in preparation of the Consolidated Financial Statements.

Merchandise inventory. Approximately 96% of the Company's inventories are valued at the lower of cost or market using the last-in, first-out retail inventory method ("LIFO RIM"). Under LIFO RIM, 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. LIFO RIM is an averaging method that is widely used in the retail industry due to its practicality. Inherent in the LIFO RIM calculation are certain significant management judgments including, among others, merchandise markon, markups, and markdowns, which significantly impact the ending inventory valuation at cost as well as the resulting gross margins. During periods of deflation, inventory values on the first-in, first-out retail inventory method ("FIFO RIM") may be lower than the LIFO RIM method. Additionally, inventory values at LIFO RIM cost may be in excess of net realizable value. At February 2, 2013 and January 28, 2012, the Company reduced the value of inventories on LIFO RIM to the FIFO RIM value, which approximates market value. Cost of sales during fiscal 2012, 2011 and 2010 under both the FIFO RIM and LIFO RIM methods was the same. The remaining 4% of the inventories are valued at the lower of cost or market using the average cost or specific identified cost methods. A 1% change in the dollar amount of markdowns would have impacted net income by approximately $10 million for fiscal 2012.


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The Company regularly records a provision for estimated shrinkage, thereby reducing the carrying value of merchandise inventory. Complete physical inventories of all of the Company's stores and warehouses are performed no less frequently than annually, with the recorded amount of merchandise inventory being adjusted to coincide with these physical counts. The differences between the estimated amounts of shrinkage and the actual amounts realized during the past three years have not been material.

Revenue recognition. The Company's retail operations segment recognizes revenue upon the sale of merchandise to its customers, net of anticipated returns of merchandise. The provision for sales returns is based on historical evidence of our return rate. We recorded an allowance for sales returns of $6.5 million and $9.0 million as of February 2, 2013 and January 28, 2012, respectively. Adjustments to earnings resulting from revisions to estimates on our sales return provision were not material for the years ended February 2, 2013, January 28, 2012 and January 29, 2011.

The Company's share of income earned under the Alliance with GE involving the Dillard's branded proprietary credit cards is included as a component of service charges and other income. The Company received income of approximately $107 million, $96 million and $85 million from GE in fiscal 2012, 2011 and 2010, respectively. Pursuant to this Alliance, the Company has no continuing involvement other than to honor the proprietary cards in its stores. Although not obligated to a specific level of marketing commitment, the Company participates in the marketing of the proprietary credit cards and accepts payments on the proprietary credit cards in its stores as a convenience to customers who prefer to pay in person rather than by paying online or mailing their payments to GE.

Revenues from CDI construction contracts are generally recognized by applying percentages of completion for each period to the total estimated revenue for the respective contracts. The length of each contract varies but is typically nine to eighteen months. The percentages of completion are determined by relating the actual costs of work performed to date to the current estimated total costs of the respective contracts. Any anticipated losses on completed contracts are recognized as soon as they are determined.

Vendor allowances. The Company receives concessions from vendors through a variety of programs and arrangements, including co-operative advertising, payroll reimbursements and margin maintenance programs.

Cooperative advertising allowances are reported as a reduction of advertising expense in the period in which the advertising occurred. If vendor advertising allowances were substantially reduced or eliminated, the Company would likely consider other methods of advertising as well as the volume and frequency of our product advertising, which could increase or decrease our expenditures. Similarly, we are not able to assess the impact of vendor advertising allowances on creating additional revenues, as such allowances do not directly generate revenues for our stores.

Payroll reimbursements are reported as a reduction of payroll expense in the period in which the reimbursement occurred.

Amounts of margin maintenance allowances are recorded only when an agreement has been reached with the vendor and the collection of the concession is deemed probable. All such merchandise margin maintenance allowances are recognized as a reduction of cost purchases. Under LIFO RIM, a portion of these allowances reduces cost of goods sold and a portion reduces the carrying value of merchandise inventory.

Insurance accruals. The Company's consolidated balance sheets include liabilities with respect to claims for self-insured workers' compensation (with a self-insured retention of $4 million per claim) and general liability (with a self-insured retention of $1 million per claim and a one-time $1 million corridor). The Company's retentions are insured through a wholly-owned captive insurance subsidiary.


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The Company estimates the required liability of such claims, utilizing an actuarial method, based upon various assumptions, which include, but are not limited to, our historical loss experience, projected loss development factors, actual payroll and other data. The required liability is also subject to adjustment in the future based upon the changes in claims experience, including changes in the number of incidents (frequency) and changes in the ultimate cost per incident (severity). As of February 2, 2013 and January 28, 2012, insurance accruals of $48.7 million and $50.3 million, respectively, were recorded in trade accounts payable and accrued expenses and other liabilities. Adjustments resulting from changes in historical loss trends have helped control expenses during fiscal 2012 and 2011, partially due to Company programs that have helped decrease both the number and cost of claims. Further, we do not anticipate any significant change in loss trends, settlements or other costs that would cause a significant change in our earnings. A 10% change in our self-insurance reserve would have affected net earnings by $3.2 million for fiscal 2012.

Long-lived assets. The Company's judgment regarding the existence of impairment indicators is based on market and operational performance. We assess the impairment of long-lived assets, primarily fixed assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:


Significant changes in the manner of our use of assets or the strategy for the overall business;


Significant negative industry or economic trends;


A current-period operating or cash flow loss combined with a history of operating or cash flow losses; or


Store closings.

The Company performs an analysis of the anticipated undiscounted future net cash flows of the related finite-lived assets. If the carrying value of the related asset exceeds the undiscounted cash flows, the carrying value is reduced to its fair value. Various factors including future sales growth and profit margins are included in this analysis. To the extent these future projections or the Company's strategies change, the conclusion regarding impairment may differ from the current estimates.

Income taxes. Temporary differences arising from differing treatment of income and expense items for tax and financial reporting purposes result in deferred tax assets and liabilities that are recorded on the balance sheet. These balances, as well as income tax expense, are determined through management's estimations, interpretation of tax law for multiple jurisdictions and tax planning. If the Company's actual results differ from estimated results due to changes in tax laws, changes in store locations, settlements of tax audits or tax planning, the Company's effective tax rate and tax balances could be affected. As such, these estimates may require adjustment in the future as additional facts become known or as circumstances change. Changes in the Company's assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income.

The total amount of unrecognized tax benefits as of February 2, 2013 and January 28, 2012 was $5.4 million and $8.5 million, respectively, of which $3.9 million and $5.8 million, respectively, would, if recognized, affect the effective tax rate. The Company classifies accrued interest expense and penalties relating to income tax in the consolidated financial statements as income tax expense. The total interest and penalties recognized in the consolidated statements of income during fiscal 2012, 2011 and 2010 was $(2.1) million, $(0.2) million, and $(2.3) million, respectively. The total accrued interest and penalties in the consolidated balance sheets as of February 2, 2013 and January 28, 2012 was $1.4 million and $3.4 million, respectively.

The Company is currently under examination by various state and local taxing jurisdictions for various fiscal years. The tax years that remain subject to examination for major tax jurisdictions are


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fiscal tax years 2009 and forward. At this time, the Company does not expect the results from any income tax audit to have a material impact on the Company's consolidated financial statements.

The Company has taken positions in certain taxing jurisdictions for which it is reasonably possible that the total amounts of unrecognized tax benefits may decrease within the next twelve months. The possible decrease could result from the finalization of the Company's various state income tax audits and lapse of statutes of limitation. The Company does not expect a material change in unrecognized tax benefits in the next twelve months.

Pension obligations. The discount rate that the Company utilizes for determining future pension obligations is based on the Citigroup Above Median Pension Index Curve on its annual measurement date and is matched to the future expected cash flows of the benefit plans by annual periods. The discount rate decreased to 4.0% as of February 2, 2013 from 4.3% as of January 28, 2012. We believe that these assumptions have been appropriate and that, based on these assumptions, the pension liability of $176 million is appropriately stated as of February 2, 2013; however, actual results may differ materially from those estimated and could have a material impact on our consolidated financial statements. A further 50 basis point change in the discount rate would increase or decrease the pension liability by approximately $11.1 million. The Company expects to make a contribution to the pension plan of approximately $4.8 million in fiscal 2013. The Company expects pension expense to be approximately $15.7 million in fiscal 2013 with a liability of $186.5 million at February 1, 2014.

RESULTS OF OPERATIONS

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

                                                     For the years ended
                              February 2, 2013        January 28, 2012        January 29, 2011
                                           % of                    % of                    % of
                                            Net                     Net                     Net
. . .
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