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Inventory Weighs Down Dillard’s

NEW YORK — Dillard’s Inc.’s bottom line sank in a sea of red ink in the second quarter as negative net and same-store sales, too much inventory and heavy markdowns conspired to hammer gross margins.<br><br>For the three months ended...

NEW YORK — Dillard’s Inc.’s bottom line sank in a sea of red ink in the second quarter as negative net and same-store sales, too much inventory and heavy markdowns conspired to hammer gross margins.

For the three months ended Aug. 2, the Little Rock, Ark.-based department store chain reported a net loss of $50.4 million, or 60 cents a diluted share. Excluding one-time aftertax charges totaling $20.9 million, or 25 cents, of which 13 cents were attributable to store closings, Dillard’s EPS fell 17 cents short of the Wall Street consensus estimate.

Investors shed their shares in a flurry of trading in which volume was almost six times average. Dillard’s stock closed down $1.51, or 8.9 percent, to settle at $15.41 in Wednesday’s New York Stock Exchange session.

Sales for the period fell 5.3 percent to $1.72 billion from $1.82 billion a year ago, and comparable-store sales declined 5 percent. Comps decreased in every month of the quarter, dropping 7 percent in May, 6 percent in June and 1 percent in July when most retailers saw sales begin to pick up.

“Clearly the results are disappointing,” said chief financial officer James?Freeman on a conference call with analysts. “Declining sales during the quarter necessitated an aggressive response to move inventory. We were very unhappy with the inventory level at the beginning of the quarter and were very aggressive with markdowns to bring those into line. This was very costly to gross margins.”

Prompted by Dillard’s dismal quarter, A.G. Edwards analyst Robert Buchanan lowered his rating to “sell” from his longstanding “hold” recommendation, reflecting the firm’s “increasingly gloomy performance outlook.”

In a scathing research note, Buchanan wrote, “Having eschewed the taking of timely markdowns for so long now — dating back to the days of founder William Dillard who seemed to regard a markdown as tantamount to an admission of failure — this approach is by now seriously damaging this retailer’s financial performance. With same-store sales having declined in four of the last five years (surely they will decline again this year) and the gross margin over that same span having dwindled by an estimated 330 basis points, Dillard’s in our view requires a new approach to its pricing strategy in short order.”

Inventories were up 5 percent over last year at the onset of the second quarter, and by its conclusion promotions had lopped 300 basis points off gross margin to 31.1 percent of sales from 34.1 percent a year ago. As of Aug. 2, inventories stood 3 percent higher than last year.

Advertising, selling, general and administrative costs dipped 30 basis points to 29.5 percent of sales, offering a modicum of comfort, Freeman said. He added that the savings were achieved primarily through payroll reductions and lower advertising costs.

Buchanan went on to excoriate the founder’s sons, Bill and Alex Dillard, chairman and president, respectively, saying the risk is that they will “remain steadfast on their current course with financial performance deteriorating as a result.” As for the likelihood of Dillard’s selling all or part of the company to a strategic buyer such as Federated Department Stores, Buchanan said the chances are “low in view of management’s historical preference to run the business on its own.”

In an operational bright spot, Dillard’s foray into private label apparel is working, as penetration of exclusive brands in stores improved to 18.2 percent of sales from 16.2 percent last year. Sales of private label did little to stem the onslaught of markdowns, however.

“We felt margin pressures everywhere,” said Freeman. “Private brands were not exempt.”

As the best of a bad lot, by merchandise category, cosmetics, accessories, shoes and lingerie performed above Dillard’s average trend. Women’s and juniors’ were in line with the firm’s total sales performance, and men’s and kids’ fared below average.

By geographic area, sales were strongest in Dillard’s western region, in line with the company’s trend in its eastern region and slightly below trend in the central region. Dillard’s operates 329 stores in 29 states spanning the Midwest, Southwest and Southeast.

For the first half of the fiscal year, Dillard’s recorded a net loss of $26 million, or 31 cents a diluted share, versus last year’s loss of $465.5 million, or $5.41. Excluding an accounting charge in last year’s period, Dillard’s would have had profits of $64.8 million, or 76 cents.

Sales for the six months dropped 5.2 percent to $3.54 billion from $3.73 billion a year ago, and comps decreased 5 percent.