Dillard'S, Inc.: Form 10-Q for the period ended May 4, 2019

The following discussion should be read in conjunction with the condensed consolidated financial statements and the footnotes thereto included elsewhere in this report, as well as the financial and other information included in our Annual Report on Form 10-K for the year ended February 2, 2019.

EXECUTIVE OVERVIEW

Despite the increase in total sales, the Company's performance in the first quarter of fiscal 2019 was disappointing as comparable store sales were essentially flat over last year's first quarter, and markdowns weighed heavily on gross margin. Gross margin from retail operations decreased 141 basis points of net sales. Selling, general and administrative expenses from retail operations decreased 23 basis points of net sales. The Company reported consolidated net income of $78.6 million ($2.99 per share) for the current year first quarter compared to consolidated net income of $80.5 million ($2.89 per share) for the prior year first quarter.

Included in net income for the quarter ended May 4, 2019 is a pretax gain on disposal of assets of $7.4 million ($5.8 million after tax or $0.22 per share). The gain on disposal of assets includes the sale of two store properties.

During the three months ended May 4, 2019, the Company purchased $17.4 million of its outstanding Class A Common Stock under its stock repurchase plan authorized by the Company's Board of Directors in March 2018 (the "March 2018 Plan"). As of May 4, 2019, authorization of $389.5 million remained under the plan.

As of May 4, 2019, the Company had working capital of $915.6 million, cash, cash equivalents and restricted cash of $148.5 million and $565.6 million of total debt outstanding, excluding finance lease liabilities and operating lease liabilities. Cash flows provided by operating activities were $48.4 million for the three months ended May 4, 2019.

The Company operated 289 Dillard's locations, including 28 clearance centers, and one internet store at May 4, 2019.

Key Performance Indicators

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

General

Net sales. Net sales includes merchandise sales of comparable and non-comparable stores and revenue recognized on contracts of CDI Contractors, LLC (“CDI”), the Company’s general contracting construction company. Comparable store sales includes sales for those stores which were in operation for a full period in both the current quarter and the corresponding quarter for the prior year. Comparable store sales excludes changes in the allowance for sales returns. Non-comparable store sales includes: 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 includes income generated through the long-term private label card alliance with Wells Fargo Bank, N.A. (“Wells Fargo Alliance”). 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, non-specific margin maintenance allowances and merchandise margin maintenance allowances), bankcard fees, freight to the distribution centers, employee and promotional discounts, shipping to customers 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 includes expenses for store leases, including contingent rent, office space and data processing and other equipment rentals.

Interest and debt expense, net. Interest and debt expense includes interest, net of interest income and capitalized interest, relating to the Company’s unsecured notes, 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 finance lease liabilities.

Other expense. Other expense includes the interest cost and net actuarial loss components of net periodic benefit costs related to the Company's unfunded, nonqualified defined benefit plan and charges related to the write-off of deferred financing fees, if any.

(Gain) loss on disposal of assets. (Gain) loss on disposal of assets includes the net gain or loss on the sale or disposal of property and equipment, as well as gains from insurance proceeds in excess of the cost basis of insured assets, if any.

Seasonality

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.

RESULTS OF OPERATIONS

The following table sets forth the results of operations as a percentage of net sales for the periods indicated (percentages may not foot due to rounding):

Net Sales

(in thousands of dollars)

21

The percent change in the Company’s sales by segment and product category for the three months ended May 4, 2019 compared to the three months ended May 5, 2018 as well as the sales percentage by segment and product category to total net sales for the three months ended May 4, 2019 are as follows:

Net sales from the retail operations segment increased $9.2 million during the three months ended May 4, 2019 compared to the three months ended May 5, 2018, increasing 1% in total while remaining flat in comparable stores. Sales of juniors' and children's apparel and home and furniture increased significantly over the first quarter last year. Sales of men's apparel and accessories increased moderately, while sales of ladies' apparel and ladies' accessories and lingerie remained relatively flat. Sales of shoes and cosmetics decreased moderately.

The number of sales transactions and the average dollars per sales transactions remained relatively flat for the three months ended May 4, 2019 compared to the three months ended May 5, 2018.

We recorded a return asset of $11.9 million and $11.7 million and an allowance for sales returns of $20.1 million and $20.0 million as of May 4, 2019 and May 5, 2018, respectively.

During the three months ended May 4, 2019, net sales from the construction segment decreased $2.0 million or 4.3% compared to the three months ended May 5, 2018 due to a decrease in construction activity. The backlog of awarded construction contracts at May 4, 2019 totaled $345.6 million, increasing approximately 3% from February 2, 2019 and increasing approximately 13% from May 5, 2018. We expect the backlog to be earned over the next nine to twenty-four months.

Service Charges and Other Income

(in thousands of dollars)

Service charges and other income is composed primarily of income from the Wells Fargo Alliance. Income from the alliance decreased during the three months ended May 4, 2019 compared to the three months ended May 5, 2018 primarily due to an increase in funding costs. Shipping and handling income decreased during the three months ended May 4, 2019 compared to the three months ended May 5, 2018 primarily due to an increase in online orders qualifying for free shipping.

Gross Profit

(in thousands of dollars)

Gross profit decreased by $16.8 million and 134 basis points of net sales during the three months ended May 4, 2019 compared to the three months ended May 5, 2018.

Gross profit from retail operations decreased 141 basis points of net sales during the three months ended May 4, 2019 compared to the three months ended May 5, 2018 primarily due to increased markdowns. Gross margin declined slightly in men's apparel and accessories and declined moderately in ladies' apparel and ladies' accessories and lingerie. Gross margin declined significantly in home and furniture, while remaining essentially flat in juniors' and children's apparel and cosmetics. Gross margin increased slightly in shoes.

Gross profit from the construction segment decreased 63 basis points of construction sales for the three months ended May 4, 2019 compared to the three months ended May 5, 2018.

Inventory increased 3% in total as of May 4, 2019 compared to May 5, 2018. A 1% change in the dollar amount of markdowns would have impacted net income by approximately $2 million for the three months ended May 4, 2019.

Selling, General and Administrative Expenses (“SG&A”)

(in thousands of dollars)

SG&A decreased 18 basis points of net sales during the three months ended May 4, 2019 compared to the three months ended May 5, 2018. SG&A from retail operations decreased 23 basis points of net sales during the three months ended May 4,

2019 compared to the three months ended May 5, 2018 mainly due to decreases in advertising ($1.9 million), supplies ($1.0 million) and services purchased ($0.6 million) partially offset by increases in payroll ($3.5 million).

Depreciation and Amortization

(in thousands of dollars)

Depreciation and amortization expense decreased $3.6 million during the three months ended May 4, 2019 compared to the three months ended May 5, 2018, primarily due to the timing and composition of capital expenditures.

Interest and Debt Expense, Net

(in thousands of dollars)

Net interest and debt expense decreased $2.8 million during the three months ended May 4, 2019 compared to the three months ended May 5, 2018, primarily due to lower average debt levels. Total weighted average debt decreased by $133.6 million during the three months ended May 4, 2019 compared to the three months ended May 5, 2018 primarily due to a note maturity.

(Gain) Loss on Disposal of Assets

(in thousands of dollars)

During the three months ended May 4, 2019, the Company recorded a gain of $7.4 million primarily from the sale of two store locations in Boardman, Ohio and Boynton Beach, Florida.

Income Taxes

The Company’s estimated federal and state effective income tax rate was approximately 22.0% for the three months ended May 4, 2019 and May 5, 2018. During the three months ended May 4, 2019 and May 5, 2018, income tax expense differed from what would be computed using the statutory federal tax rate primarily due to the effect of state and local income taxes partially offset by tax benefits recognized for federal tax credits.

The Company expects the fiscal 2019 federal and state effective income tax rate to approximate 21% to 22%. This rate may change if results of operations for fiscal 2019 differ from management’s current expectations. Changes in the Company’s assumptions and judgments can materially affect amounts recognized in the condensed consolidated balance sheets and statements of income.

FINANCIAL CONDITION

A summary of net cash flows for the three months ended May 4, 2019 and May 5, 2018 follows:

(in thousands of dollars)

Net cash flows from operations decreased $7.0 million during the three months ended May 4, 2019 compared to the three months ended May 5, 2018. This decrease was primarily attributable to the net change in accounts payable and merchandise inventories.

Wells Fargo owns and manages the Dillard's private label cards under the Wells Fargo Alliance. Under the Wells Fargo Alliance, Wells Fargo establishes and owns private label card accounts for our customers, retains the benefits and risks associated with the ownership of the accounts, provides key customer service functions, including new account openings, transaction authorization, billing adjustments and customer inquiries, receives the finance charge income and incurs the bad debts associated with those accounts.

Pursuant to the Wells Fargo Alliance, we receive on-going cash compensation from Wells Fargo based upon the portfolio's earnings. The compensation received from the portfolio is determined monthly and has no recourse provisions. The amount the Company receives is dependent on the level of sales on Wells Fargo accounts, the level of balances carried on Wells Fargo accounts by Wells Fargo customers, payment rates on Wells Fargo accounts, finance charge rates and other fees on Wells Fargo accounts, the level of credit losses for the Wells Fargo accounts as well as Wells Fargo's ability to extend credit to our customers. We participate in the marketing of the private label cards, which includes the cost of customer reward programs. The Wells Fargo Alliance expires in fiscal 2024.

The Company received income of approximately $21 million and $22 million from the Wells Fargo Alliance during the three months ended May 4, 2019 and May 5, 2018, respectively.

Capital expenditures were $18.7 million and $39.2 million for the three months ended May 4, 2019 and May 5, 2018, respectively. The capital expenditures were primarily related to equipment purchases and the remodeling of existing stores during the current year. Capital expenditures for fiscal 2019 are expected to be approximately $140 million compared to actual expenditures of $137 million during fiscal 2018.

During the three months ended May 4, 2019, the Company received cash proceeds of $13.4 million and recorded a related gain of $7.4 million for the sale of two store locations in Boardman, Ohio and Boynton Beach, Florida. The proceeds from the Boardman, Ohio store sale are being held in escrow for the acquisition of replacement property under like-kind exchange agreements. The escrow accounts are administered by an intermediary. Pursuant to the like-kind exchange agreements, the cash is restricted for a maximum of 180 days from the date of the property sale pending the acquisition of replacement property. As of May 4, 2019, the acquisition of replacement property had not yet occurred; therefore, the proceeds were classified as restricted cash on the condensed consolidated balance sheets.

During the three months ended May 5, 2018, the Company received cash proceeds of $1.9 million from the sale of a location classified as an asset held for sale. These proceeds were being held in escrow for the acquisition of replacement property under like-kind exchange agreements. As of May 5, 2018, the acquisition of replacement property had not yet occurred; therefore, the proceeds were classified as restricted cash on the condensed consolidated balance sheets.

Subsequent to May 4, 2019, we closed the Boardman, Ohio (186,000 square feet) and the Muskogee, Oklahoma (70,000 square feet) store locations. We remain committed to closing under-performing stores where appropriate and may incur future closing costs related to such stores when they close.

The Company had cash on hand of $139.8 million as of May 4, 2019. As part of our overall liquidity management strategy and for peak working capital requirements, the Company maintains an unsecured revolving credit facility that provides a borrowing capacity of $800 million with a $200 million expansion option ("credit agreement"). The credit agreement is available to the Company for general corporate purposes including, among other uses, working capital financing, the issuance of letters of credit, capital expenditures and, subject to certain restrictions, the repayment of existing indebtedness and share repurchases. The rate of interest on borrowings is LIBOR plus 1.375%, and the commitment fee for unused borrowings is 0.20% per annum. To be in compliance with the financial covenants of the credit agreement, the Company's total leverage ratio cannot exceed 3.5 to 1.0, and the Company's coverage ratio cannot be less than 2.5 to 1.0, as defined in the credit agreement. At May 4, 2019, the Company was in compliance with all financial covenants related to the credit agreement.

At May 4, 2019, no borrowings were outstanding, and letters of credit totaling $21.8 million were issued under the credit agreement leaving unutilized availability under the facility of $778.2 million.

During the three months ended May 4, 2019, the Company repurchased 0.2 million shares of Class A Common Stock at an average price of $70.85 per share for $17.4 million (including the accrual of $2.0 million of share repurchases that had not settled as of May 4, 2019) under the Company's March 2018 Plan. During the three months ended May 5, 2018, the Company repurchased 0.5 million shares of Class A Common Stock at an average price of $72.77 per share for $34.8 million. Additionally, the Company paid $2.0 million for share repurchases that had not yet settled but were accrued at February 3, 2018. At May 4, 2019, $389.5 million of authorization remained under the March 2018 Plan. The ultimate disposition of the repurchased stock has not been determined.

During fiscal 2019, the Company expects to finance its capital expenditures, working capital requirements and stock repurchases from cash on hand, cash flows generated from operations and utilization of the credit facility. Depending on conditions in the capital markets and other factors, the Company may from time to time consider other possible financing transactions, the proceeds of which could be used to refinance current indebtedness or for other corporate purposes.

There have been no material changes in the information set forth under caption “Contractual Obligations and Commercial Commitments” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2019.

OFF-BALANCE-SHEET ARRANGEMENTS

The Company has not created, and is not party to, any special-purpose entities or off-balance-sheet arrangements for the purpose of raising capital, incurring debt or operating the Company’s business. The Company does not have any off-balance-sheet arrangements or relationships that are reasonably likely to materially affect the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or the availability of capital resources.

NEW ACCOUNTING STANDARDS

For information with respect to new accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 2, Accounting Standards, in the "Notes to Condensed Consolidated Financial Statements," in Part I, Item I hereof.

FORWARD-LOOKING INFORMATION

This report contains certain forward-looking statements. The following are or may constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995: (a) statements including words such as “may,” “will,” “could,” “should,” “believe,” “expect,” “future,” “potential,” “anticipate,” “intend,” “plan,” “estimate,” “continue,” or the negative or other variations thereof; (b) statements regarding matters that are not historical facts; and (c) statements about the Company’s future occurrences, plans and objectives, including statements regarding management’s expectations and forecasts for the remainder of fiscal 2019 and beyond, statements concerning the opening of new stores or the closing of existing stores, statements concerning capital expenditures and sources of liquidity, statements concerning share repurchases, statements concerning pension contributions and statements concerning estimated taxes. The Company cautions that forward-looking statements contained in this report are based on estimates, projections, beliefs and assumptions of management and information available to management at the time of such statements and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise. Forward-looking statements of the Company involve risks and uncertainties and are subject to change based on various important factors. Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements made by the Company and its management as a result of a number of risks, uncertainties and assumptions. Representative examples of those factors include (without limitation) general retail industry conditions and macro-economic conditions; economic and weather conditions for regions in which the Company's stores are located and the effect of these factors on the buying patterns of the Company's customers, including the effect of changes in prices and availability of oil and natural gas; the availability of consumer credit; the impact of competitive pressures in the department store industry and other retail channels including specialty, off-price, discount and Internet retailers; changes in consumer confidence, spending patterns, debt levels and their ability to meet credit obligations; high levels of unemployment; changes in tax legislation; changes in legislation, affecting such matters as the cost of employee benefits or credit card income; adequate and stable availability of materials, production facilities and labor from which the Company sources its merchandise at acceptable pricing; changes in operating expenses, including employee wages, commission structures and related benefits; system failures or data security breaches; possible future acquisitions of store properties from other department store operators; the continued availability of financing in amounts and at the terms necessary to support the Company's future business; fluctuations in LIBOR and other base borrowing rates; the potential impact on the Company's debt obligations of developments regarding LIBOR, including the potential phasing out of this metric; potential disruption from terrorist activity and the effect on ongoing consumer confidence; epidemic, pandemic or other public health issues; potential disruption of international trade and supply chain efficiencies; world conflict and the possible impact on consumer spending patterns and other economic and demographic changes of similar or dissimilar nature. The Company's filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the fiscal year ended February 2, 2019, contain other information on factors that may affect financial results or cause actual results to differ materially from forward-looking statements.

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 February 2, 2019.

The Company has established and maintains disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). The Company’s management, with the participation of our Principal Executive Officer and Co-Principal Financial Officers, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the fiscal quarter covered by this quarterly report, and based on that evaluation, the Company’s Principal Executive Officer and Co-Principal Financial Officers have concluded that these disclosure controls and procedures were effective.

There were no changes in our internal control over financial reporting that occurred during the fiscal quarter ended May 4, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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 February 2, 2019.