Dillard’s_Analysis_2010

November 9, 2010 [DILLARD’S INC.] TABLE OF CONTENTS Our Path to Dillard’s Company Overview Segments Competitive Advantage Macroeconomic Analysis Industry Analysis A Cyclical Industry Competitors SWOT Analysis Porter’s Five Forces The Turnaround Strategic Plan About the Dillard Family The Potential Proxy Battle of 2008 Share Repurchase Programs Making Room for Dillard’s in the SMF Portfolio Ratio Analysis Pro Forma Income Statement Pro Forma Balance Sheet Valuation Recommendation & Conclusion Appendix Value Line Analysis 2 3 3 4 4 8 10 11 12 12 14 15 16 17 ___ 17 ___ 19 ___ 24 ___ ______ 27 _____________________________ 29 _________ 33 __ 34 __37 Page 1 November 9, 2010 [DILLARD’S INC.] OUR PATH TO DILLARD’S As we began to search for a promising company to invest in during the second round of stock presentations, our team’s major focus was to find a cyclical company with the potential to provide promising returns as the country slowly climbed out of the recession. We noted that the retail industry had historically reacted cyclically to economic conditions and, more importantly, was a leading industry during times of economic growth. Another focus was on the current imbalances in our portfolio. The SMF portfolio has a very small percentage, as compared to the S&P 500’s, of consumer discretionary. Also, the portfolio lacks holdings in major retail industry players. With this in mind, we set out to find a stock within this particular industry that showed potential. Noting that SMF’s current portfolio beta averages at 1.01, we also thought that a riskier company might provide the opportunity of higher returns and increase the riskiness of our overall portfolio. Furthermore, we discussed the possibility of the Great Recession producing some strong turnaround candidates. We looked for companies who had been badly beaten down by the recent recession but still had strong fundamentals and were undertaking changes to return to pre-recession values. This process ultimately led us to select Dillard’s Inc., a company that began drowning in 2007, but has since designed a repositioning strategy that cut costs and increased profits in 2009. Key Points: Our Path to DDS Looking for: Cyclical company – Why' Provide higher returns coming out of the recession Looking for: Retail Company – Why' SMF portfolio has no major retail industry players Looking for: Higher risk company – Why' SMF portfolio beta averages at 1.01 Looking for: Turnaround company – Why' Brings more risk into the portfolio and potentially higher returns Dillard’s Inc. Page 2 November 9, 2010 [DILLARD’S INC.] COMPANY OVERVIEW Dillard’s Inc. is ranked among the nation’s largest apparel and home furnishing retailers.1 It was founded in 1938 and incorporated in Delaware in 1964. They currently operate 309 stores, including 12 clearance centers. The stores are located primarily in shopping malls in the Southwest, Southeast, and Midwest regions of the United States. Customers may also purchase products online at www.dilliards.com. Dillard’s is seen as a high fashion retailer that aims to operate in a middle market between luxury stores like Saks Fifth Avenue and discount retailers like Macy’s. Dillard’s offers name brands such as Roundtree & Yorke, Antonio Melani, Gianni Bini and Daniel Cremieux.2 As with most all retailers, Dillard’s is a cyclical company and receives a large amount of its revenues during the holiday season. To allow for these earnings to be reflected, Dillard’s operates within a fiscal year ending January 31st. As the economy recovers and consumer confidence increases, Dillard’s revenues are likely to increase.3 SEGMENTS 2010 Sales % of Total 7% 8% 14% 3% 36% Women's apparel & accessories Men's apparel & accessories Cosmetics Shoes 15% 17% Juniors' & children's apparel The most significant revenue source is for Dillard’s is Women’s apparel.4 An article from the Dallas Morning News states that women’s shoes have been the first sector to recover since the 1 2 Hoover’s Company Overview Dillard’s 2009 Annual Report 3 Seeking Alpha: “JC Penney and Dillard’s – Two retail stocks for Christmas.” 4 Page 3 The Dallas Morning News:“Men’s apparel plots comeback after slow sales during recession.” Maria Halkias, November 9, 2010 [DILLARD’S INC.] recession and predict that women’s apparel will be next as consumer confidence continues to increase. Dillard’s home and furniture segment also expects continued expansion over the coming years. COMPETITIVE ADVANTAGE The overall goal of Dillard’s strategic restructuring is illustrated in Dillard’s “Turnaround Strategic Plan” found on page 14. Starting in 2008, the realignment of corporate goals, along with the installment of new board members, has enabled Dillard’s to reinvent itself in the marketplace. In a conversation with Julie Bull, Director of Investor Relations at Dillard’s, Ms. Bull defined Dillard’s competitive advantage as the following: “Our competitive advantage is our improved merchandise mix - as we have sought and achieved an improved assortment to set ourselves apart in the marketplace. Quite frankly, there is no reason to look like our peers, so we have set out to look dramatically different - and the key is improved merchandise.” Exclusive brand merchandise has accounted for 23.8% of sales in FY 10 for Dillard’s.2 As the retail industry and the economy as a whole continue to turnaround, Dillard’s competitive advantage will only increase. MACROECONOMIC ANALYSIS Since the recession ended in June 2009, growth has persisted for five straight quarters.5 Although growth was initially sluggish, third quarter results in 2010 show a much larger increase in growth. Recent economic indicators, as well as government actions, support the belief that the economy is indeed recovering and retail is on the forefront of this growth. Almost all signs point to even more growth in the fourth quarter of 2010, which means that the United States, and specifically retailers, will have a very Merry Christmas. 5 U.S. Census Bureau Page 4 November 9, 2010 [DILLARD’S INC.] Macroeconomic Indicators6 Personal Income Personal Consumption Retail Store Sales Business Inventories Consumer Confidence Index of Leading Indicators  3.54% Yr Change (Sept) 1.89 % Yr Change (3rd Qtr) 7.34 % Yr Change (Sept) 4.72 % Yr Change (Aug) 3.08 % Yr Change (Oct) 6.67% Yr Change (Sept) The U.S. Bureau of Economic Analysis reported 2.0 percent growth in real gross domestic product and real consumer spending for the third quarter of 2010. Real consumer spending is expected to increase by 2.4 percent in the fourth quarter of 2010.6  According to SpendingPulse, a macro-economic indicator that reports on national retail and services sales, since October 2010 “year-over-year overall apparel sales were up a sharp 8.2%, building on the 3.8% gain in September.7 October saw the year’s largest year-over-year increase for the sector, which has enjoyed 7 out of 10 months of year-over-year gains so far in 2010. Within the sector, women’s apparel enjoyed a 5.3% year-over-year gain, while the Children’s and Family segments saw solid gains.”8  “In the eCommerce sector, sales posted a year-over-year growth rate on par with those of August and September. With an increase of 7.9%, the overall sector is up slightly higher than September’s year-over-year gain of 7.8%, and August’s 7.2% increase.”5 6 7 8 Barron’s Weekly Businesswire.com: SpendingPulse Page 5 The Wall Street Journal November 9, 2010 [DILLARD’S INC.]  The United States experienced an unexpected increase in jobs in October. The U.S saw an increase of 151,000 jobs, mostly acquired in the private sector.5  On Thursday, November 4th, the Dow industrial leapt to 11,434.84, a high that hasn’t been seen since before the Lehman bankruptcy two years ago.5 Government Action during the first week of November  The Federal Reserve announced that it would pump at least $600 billion into the financial system in an attempt to revive the economy by further pushing down interest rates. Although this could mean inflation in the long run, the short term effects of lower interest rates will be cheaper borrowing and higher stock prices as investors are looking for riskier investments that offer higher returns. This could “encourage households to spend more and businesses to invest more, and a weak dollar could make U.S exports cheaper and thus easier to sell abroad. According to Ben Bernanke, “this approach eased financial conditions in the past, and so far, looks to be effective again.” 6 Page 6 November 9, 2010  [DILLARD’S INC.] This week the Federal Reserve is expected to announce the guidelines that banks must meet in order to start increasing dividend payments. Banks have not been allowed to increase dividend payments since the financial crisis and this could lead to boosts in bank stocks.8  Economic data strongly suggests that department store retail sales are highly correlated with the growth of the economy, and specifically GDP. Peter Lynch notes that “if it’s a cyclical company you’re thinking about, then your script revolves around business conditions, inventories, and prices.” Therefore, being able to get a best estimate of future economic predictions greatly increases ones chances of being able to properly time a cyclical stock. The U.S. Bureau of Economic Analysis came out with the following predictions for 2010 and 2011. 2010 II Q* Real GDP 1.7 III Q 1.5 2.0 0.59 4.9 IV Q 1.3 2.4 0.62 2.5 2011 IQ II Q 0.4 0.5 0.68 1.6 1.2 1.3 0.69 1.9 2009 2010 2011 III Q Annual Annual Annual 2.0 2.1 0.70 4.9 -2.6 -1.2 0.55 -17.1 2.6 1.6 0.61 4.8 1.2 1.6 0.70 3.6 Real Consumer Spending 2.2 Housing Starts mil. Units Real Capital Spending Net Exports Bil. '00$ 0.60 17.2 -449.1 -475.9 -465.5 -467.0 -473.3 -488.1 -363.0 -432.3 -480.4  Although the UBEA expects a decrease in the growth rate of real GDP in the first quarter of 2011, real GDP and consumer spending are predicted to continue to grow. As the economy continues to turn around, the retail sector will follow. Peter Lynch notes that “cyclicals may be a low-risk and high-gain …depending on how adept you are to anticipating cycles” (244).9 9 Peter Lynch. One Up On Wall Street. Page 7 November 9, 2010 [DILLARD’S INC.] INDUSTRY ANALYSIS Dillard’s Inc. occupies a unique niche market in the retail industry. The retail industry is composed of a variety of companies that offer consumer goods such as apparel, footwear, housewares, and home furnishings.1 In addition, the industry represents a mature portfolio of companies which respond in a cyclical manner to business cycles. Throughout the most recent recession, Dillard’s net sales fell (around 11% in 2009) as people spent less on nonnecessities.2 Within this industry, Dillard’s competes inside the department store sub industry which includes household names like JCPenney and Macy’s. Dillard’s is currently positioned between luxury department stores such as Saks and retail Snapshot: Industry Statistics Market Cap.: $20B Price / Earnings: 14.8 Price / Book: 2.4 Net Profit Margin: 2.7% Return on Equity: 11.3% Total Debt / Equity: 59.5 powerhouses such as Macy’s, allowing it to occupy an unsaturated market niche.1 The company’s aspiration of gaining market dominance between mid-priced department stores such as Macy’s and upscale department stores such as Saks will allow Dillard’s to capitalize on neglected consumers who fall in between these two markets. The total market capitalization of the department store division of the retail industry totals around $20B, with Dillard’s contributing roughly 8% at a total market capitalization of $1.64B.2 Net profit margins for the industry hover around 2.7%, and total debt to equity stands at 59.5.10 Dillard’s currently holds a reputation as a laggard in the industry due to its past performance. However, due to its practices aimed at revamping strategy, increasing efficiency, and stronger consumer targeting, the company is a positioned on a launch pad for future success within the industry. Department stores, unlike major discount chains like Wal-Mart, tend to have a “loyal following” of consumers who view department store products as higher quality.1 The industry also tends to 10 Yahoo! Finance Page 8 November 9, 2010 [DILLARD’S INC.] experience a boost in sales in the 4th quarter as consumers increase purchases in preparation for the Christmas season.3 While this industry tends to be at the mercy of consumer optimism, Dillard’s and other department stores will be attempting to offset any consumer worries about the weakening dollar with strong promotions in anticipation of the Christmas season.3 The graph below exhibits the S&P 500 Department Store Index. As shown, the market tends to favor department stores as we head into the 4th quarter. S&P 500 Department Stores Index Source: Bloomberg Key Points: Industry Analysis Department store division of retail industry represents cyclical, mature companies. Dillard’s is attempting to occupy a position between high-priced and mid-priced department stores in the industry. Department stores tend to have “loyal following” of customers. Department stores typically experience fourth quarter boost in sales. Consumer optimism heavily dictates this industry. Page 9 November 9, 2010 [DILLARD’S INC.] A CYCLICAL INDUSTRY In analyzing a cyclical company Lynch states that “timing is everything in cyclicals, and you have to be able to detect the early signs that business is falling off or picking up.”9 The graph below illustrates the cyclicality of U.S. department store retail sales and the business cycle. The fluctuations in retail sales are closely tied to the movements in real GDP. Real GDP has continued to gain momentum throughout 2010 and overall U.S. retail sales are following closely behind. The graph below looks at the correlation between returns from the S&P Department Store index, S&P 500 index, and Dillard’s. Since 2010, Dillard’s has not only beaten the S&P 500, but it has also beaten the S&P Department Store Index. Source: Bloomberg Page 10 November 9, 2010 [DILLARD’S INC.] COMPETITORS Macy’s is the top department store chain in the U.S. The company operates around 850 stores across the U.S. Macy’s sells men’s, women’s and children’s clothing in addition to housewares and cosmetics. Macy’s operates its stores under two names including Bloomingdale’s and Macy’s. This department store giant is currently attempting to stimulate growth through localization. Bloomingdale’s sells Macy’s upscale line of products, including brands such as Jimmy Choo and Ralph Lauren. By keeping its Macy’s brand stores mid-priced and its Bloomingdale’s brand stores catered to upper class customers, Macy’s stretches its presence into two market segments. Saks Fifth Avenue is a subsidiary of Saks Incorporated, and positions itself as a luxury department store in the retail industry. Offering brand names such as Chanel and Burberry, this department store chain is composed of around 50 stores throughout the U.S. The company is currently attempting to attract younger shoppers, in addition to the current market base of middle-aged women. JCPenney has the largest apparel and home furnishing sites on the Internet, jcp.com, and the nation's largest general merchandise catalog business. JCPenney offers a wide array of national, private and exclusive brands which reflect the Company's commitment to providing customers with style and quality at compelling prices. They operate 1,108 department stores across the U.S. and Puerto Rico. 10 11 2009 Macy’s Annual Report 2009 Saks Inc. Annual Report 12 2009 JCPenney Annual Report Page 11 November 9, 2010 [DILLARD’S INC.] SWOT ANALYSIS1,2 Strengths  Achieved 410 basis point increase in merchandise gross margin in 2009  Strong consumer loyalty  Strong focus on apparel and home furnishings  Owns 75% of its stores as well as a majority of its distribution centers  Owns CDI Contractors, construction company created to construct Dillard’s stores  Commitment to offering quality, namebrand merchandise Opportunities  Moving towards upscale niche (Under Nordstrom’s and above Macy’s)  Increasing fashion options  Positioning in open-air “lifestyle centers” as opposed to indoor malls Weaknesses  Entrenched family management team  Regional department store that faces competition from national department stores  Ownership of stores exposes company to liabilities and losses  Still recovering from recessionary environment Threats  Possibility of consumer pessimism in response to weakening dollar  Price competition from lower-end competitors As Dillard’s begins to recover from the recession, the company can take advantage of the opportunity to reposition itself as an upper-scale department store that offers unique brand name apparel and merchandise. Furthermore, it is hoped that the consumer loyalty historically displayed by the department store customers will offset the threats presented by potential consumer pessimism and price competition from lower-end competitors as the company heads into the fourth quarter. PORTER’S FIVE FORCES Buyer Power-High Consumers have countless options when it comes to retail outlets. Buyers can switch outlets at little or no cost to themselves. However, Dillard’s mid-market pricing strategy keeps it in a unique niche between upscale department stores such as Nordstrom and discount chains such as T.J. Maxx. In addition, Dillard’s offers differentiated brand names that are only available through their outlets. Despite this, the large number of competitors in the industry still puts buyer power at a high level. Page 12 November 9, 2010 Supplier Power-Low [DILLARD’S INC.] Retail outlets historically have had much power over their suppliers. Because there are so many suppliers to choose from, suppliers tend to be at the mercy of department stores and often match quality demands from certain outlets. Competitive Rivalry-High Competitive rivalry in this industry is very high. Competitive advantages are often gained through brand loyalty, which Dillard’s currently holds with upper-middle class women. The price competition offered by rivaling department stores is intense. Threat of New Entrants-Low This industry is extremely capital intensive. The presence of independent retailers in indoor and outdoor malls has grown smaller, as it becomes more difficult for such smaller companies to gain valuable market share. Dillard’s is mostly concerned with existing chain department stores that have an entrenched market presence. Threat of Substitutes-High Once again, the presence of multiple department store giants such as Macy’s and J.C. Penney allows for buyer access to similar buffets of product offerings across the industry. It is relatively simple for a consumer to substitute the array of products found at one department store for another. Overall Assessment: Porter’s Five Forces The department store division of the retail industry faces stiff price competition among similar stores. Due to the high buyer power, high competitive rivalry, and high threat of substitutes present in this industry, Dillard’s must be able to show consumers that their unique department store experience offers value above that of competitors. Dillard’s is currently addressing this through their offering of unique name brands in their stores. Page 13 November 9, 2010 [DILLARD’S INC.] THE TURNAROUND STRATEGIC PLAN2 Improve merchandise mix Eliminate/Replace underperforming products Tailor to local demographics Strategic Plan Goals: Focus on stores with lower occupancy costs Increase Market Share Increase Profitability Reposition DDS as a mid-upper scale department store Enter/Further penetrate markets in which DDS can become dominant department store operator Improve website Generate higher profits on less volume Page 14 November 9, 2010 [DILLARD’S INC.] ABOUT THE DILLARD FAMILY2 William Dillard, II: Serves as Chairman of the Board and CEO of DDS William Dillard, II is the son of the company’s founder, William Dillard. Dillard has worked full-time for the company for over 40 years and serves on the Boards of Directors for Axiom Corporation and Barnes & Noble, Corp. Mike Dillard: Serves as Executive Vice-President of DDS Mike Dillard, the youngest of the Dillard brothers, contributes his understanding of regional characteristics of merchandising to DDS. Alex Dillard: President of DDS Alex Dillard, formerly serving as Executive Vice-President of DDS, applies understanding of both merchandising and operational aspects of the retail business to increase profitability of DDS. Dillard serves as a board member for Union Bank, Worthen Bank, and First National Bank of Ft. Worth, Texas. Executive Compensation in 2009 Name William Dillard, II Alex Dillard Mike Dillard Salary $ 810,000 $ 720,000 $ 610,000 Bonus $ $ $ Stock Awards 454,235 448,731 36,404 Security Ownership of Management Name Robert C. Connor Alex Dillard III Mike Dillard III William Dillard II James I. Freeman H. Lee Hastings Peter R. Johnson R. Brad Martin Drue Matheny Frank R. Mori Warren A. Stephens J.C. Watts, Jr. Nick White Amount Class A Shares % of Class 64,129 0.10% 1,832,875 2.70% 1,272,035 1.90% 1,538,262 2.30% 737,192 1.10% 10 * 43,536 0.10% 107,500 0.20% 656,986 1.00% 10,000 * 146,536 0.20% 10,500 * 37,000 0.10% Amount Class B Shares % of Class 3,985,776 99.40% 3,985,776 99.40% 3,985,776 99.40% - Page 15 November 9, 2010 [DILLARD’S INC.] Assessment: While the Dillard family holds extremely high stakes in the Dillard’s brand, DDS’s Board of Directors serves as a balancing mechanism between family interests and the interests of the company. As evidenced by the proxy battle scare of 2008, shareholders who find the Dillard brothers incompetent will not hesitate to take action. It is our belief that although the Dillard family management team is criticized by some shareholders, the expertise and desire that they as a family have for the brand name to succeed are undeniable. Moreover, the presence of four new directors with valuable experience in retail areas such as Saks, Anne Klein, and Wal-Mart, bring expertise to the board that, when combined with that of the Dillards’, will promote future success for the company as a whole. POTENTIAL PROXY BATTLE OF 200813 As mentioned previously, DDS faced a potential proxy battle as it headed into the annual meeting of 2008. As DDS’s revenues continued to decline in 2007, Barington Capital Group, an investment firm that historically invests in undervalued companies, announced a 3.2% ownership in the company to CEO William T. Dillard, II. Barington Capital Group had previously taken part in increasing shareholder value at other retail outlets including Steve Madden and Payless ShoeSource. In a letter written to DDS’s Board of Directors, Barington Capital Group expressed concerns about the Dillard management team and their ability to maximize shareholder value. By March of 2008, Barington Capital Group announced its intentions to nominate four new board members at the upcoming annual meeting in May including: James A. Mitarotonda – President and CEO of Barington Capital Group Charles M. Elson – A leading expert in the area of corporate governance Nick White – Former executive of Wal-Mart Stores, Inc. Eric S. Salus – Former President of Macy’s Home Store 13 S&P Industry Report Page 16 November 9, 2010 [DILLARD’S INC.] DDS responded by nominating four alternative board members, ultimately avoiding a proxy battle with Barington Capital Group. The four new board members would be: Brad Martin - Former Chairman and CEO of Saks Inc. Frank R. Mori – Former President and CEO of Anne Klein, Inc. Nick White – Former executive at Wal-Mart Stores, Inc. James A. Haslam, III – CEO of Pilot Travel Centers LLC Since the election of these experienced board members in 2008, Barington Capital Group has substantially decreased their ownership interests in DDS.As mentioned earlier, it is our belief that the presence of these four experts from various fields within the retail industry will allow Dillard’s to propel itself into the forefront of the department store division. SHARE REPURCHASE PROGRAMS May 2005: $200 million share repurchase plan for Class A Common Stock approved – completed in 3rd quarter of 20072 November 2007: $200 million share repurchase plan of Class A Common Stock approved – completed in 2nd quarter of 20102 August 2010: $250 million share repurchase plan of Class A Common Stock approved2 Assessment: Dillard’s has consistently instituted share repurchasing programs in recent years. It is our belief that Dillard’s has established this program out of their concern for shareholders and the maximization of shareholder value. Moreover, the consistent application of these programs indicates that the Dillard’s management team believes that DDS is a good investment. MAKING ROOM FOR DILLARD’S IN THE SMF PORTFOLIO At first glance, Dillard’s beta of 1.75 may seem rather high and risky compared to the market. However, the table below is a risk analysis performed on the Student Managed Fund portfolio with the inclusion of Dillard’s. The market weighted beta of the SMF portfolio including Dillard’s is 1.05. The Page 17 November 9, 2010 [DILLARD’S INC.] current market weighted beta without the inclusion of Dillard’s is only 1.01. The market weighted beta of the portfolio does not change by much with the inclusion of Dillard’s, because the less risky stocks in SMF’s portfolio work to counter balance the few riskier stocks. The table below also provides information on the diversification of SMF’s portfolio. SMF’s portfolio is underweighted in the consumer discretionary sector and zero percent of SMF’s portfolio is weighted in the retail subsector. With the inclusion of Dillard’s, Consumer Discretionary accounts for 7.4% of the portfolio. Without Dillard’s, only 2.4% of SMF’s portfolio is weighted in Consumer Discretionary while 10.59% of the S&P 500 is weighted in Consumer Discretionary. Although the goal of SMF is to beat and not to replicate the S&P 500, it should be pointed out that our portfolio’s return is highly correlated with the success or shortcomings of the IT sector. SMF has lost to the S&P 500 for the last three quarters! Risk Analysis of SMF Portfolio Company S&P 500 ETF Cerner Corporation FactSet Research Systems. Inc. Oracle Corporation Google, Inc. Zerox Activision Blizzard, Inc. Visa, Inc. Stericycle L-3 Holdings Diana Shipping, Inc. Curtiss-Wright Corporation Mosaic Company Ball Corporation Occidental Petroleum Corporation Goldman Sachs Group, Inc. The NASDAQ OMX Group,Inc Wells-Fargo & Company Information Technology Information Technology Information Technology Information Technology Information Technology Information Technology Information Technology Industrials Industrials Industrials Industrials Materials Materials Energy Financials Financials Financials Sector Market Value of Portfolio 306,322.50 87,510.00 70,488.00 59,065.00 61,560.00 55,084.00 39,015.00 23,526.00 65,187.00 47,528.00 31,027.00 15,645.00 71,770.00 32,145.00 81,510.00 40,705.00 32,250.00 10,388.00 Percentage of Market Value 23.60 6.74 5.43 4.55 4.74 4.24 3.01 1.81 5.02 3.66 2.39 1.21 5.53 2.48 6.28 3.14 2.48 0.80 Beta 0.99 0.85 1.00 0.90 0.90 1.25 0.75 1.10 0.65 0.90 1.55 1.15 1.60 0.95 1.20 1.25 1.30 1.35 Page 18 Teva Pharmaceutical Industries Quest Diagnostics, Inc. PetMed Express, Inc. Dillard’s, Inc. Total SMF Market Weighted Beta Health Care Health Care Consumer Discretionary Consumer Discretionary 40,744.00 30,228.00 32,200.00 64,050.00 1,297,947.50 3.14 2.33 2.48 4.93 100.00 0.55 0.70 0.75 1.75 1.05 FINANCIAL RATIOS How to Read Our Ratios: For each ratio category, we’ve broken it up to show Dillards’ ratios, and then compared DDS’ most current year with the competitors. Significant ratios are colored in order to highlight the strong and weak areas of DDS. For the first category (DDS’ ratios), we’ve compared DDS’ most current year (2009) with their five year average to show how DDS is doing compared to prevous years. For the second categroy (DDS vs Comp), we’ve compared DDS’ most recent year to the industry average. Green figures indicate DDS is doing better than the benchmark; red figures indicate DDS is doing worse than the benchmark. Forward ratios are based on our pro forma income statement and pro forma balance sheet. Liquidity Dillard’s Quick Ratio Current Ratio Average 0.33 1.95 2009 0.58 2.28 2008 0.34 1.85 2007 0.14 1.64 2006 0.28 2.10 2005 0.30 1.87 Competitors Quick Ratio Current Ratio DDS 2009 0.58 2.28 Industry Median 0.60 1.69 JCP 1.12 2.05 M 0.51 1.55 SKS 0.73 2.44 Dillard’s liquidity has been improving in recent years. Typical to the retail industry, most of DDS’ current assets are in inventory. DDS’ quick ratio and high current ratio indicates that Dillard’s holds more inventory and less cash equivalents compared to its competitors. However, with a current ratio of 2.28, we feel Dillard’s has strong short term liquidity. 19 Dillard’s Forward Quick Ratio Current Ratio 2011 0.87 2.78 2010 0.75 2.65 2009 0.58 2.28 Asset Management Dillard’s* Total Asset Turnover Days Sales Inventory Fixed Asset Turnover Competitors Total Asset Turnover Days Sales Inventory Fixed Asset Turnover Average 1.41 123 2.36 DDS 2009 1.35 116 2.24 2009 1.35 116 2.24 2008 1.47 104 2.35 2007 1.38 136 2.31 JCP 1.40 104 3.28 2006 1.45 129 2.48 M 1.10 121 2.47 2005 1.39 131 2.44 SKS 1.23 142 2.75 Industry Median 1.40 108 n/a Dillard’s management has not done a great job in asset management in the past few years. We would like to see higher asset turnovers. However, DDS has decreased inventory holdings in the past two years, mostly associated with lower revenues. Note: Average collection days was excluded because DDS does not own a credit card business. 5 year average is 1.99 days; industry median is 33.7 days. Dillard’s Forward Total Asset Turnover Days Sales Inventory Fixed Asset Turnover 2011 1.44 123 2.67 2010 1.45 123 2.57 2009 1.35 116 2.24 Debt Management Dillard’s Debt/Equity Equity Multiplier Interest Coverage Average Payment Period Competitors Debt/Equity Equity Multiplier Interest Coverage Average Payment Period Average 1.14 2.41 1.47 57 DDS 2009 1.00 2.00 1.14 60 2009 1.00 2.00 1.14 60 2008 1.11 2.11 nm 49 2007 1.12 2.12 0.66 59 JCP 1.63 2.63 2.55 42 2006 1.09 2.09 2.90 58 M 3.53 4.53 1.89 34 2005 1.36 2.36 1.19 62 SKS 0.99 1.99 nm 22 Industry Median 0.55 1.55 3.94 n/a 20 Dillard’s has made improvements in decreasing their long-term debt. However, as the ratios indicate, DDS is leveraged more than its competitors. Because we are bullish about the retail industry, we see their higher leverage as a positive. Dillard’s high debt can be attributed to $400 million in share buy backs between 2005 to 2010. Dillard’s Forward Debt/Equity Equity Multiplier Interest Coverage Average Payment Period 2011 0.93 1.93 2.81 57 2010 1.00 2.00 2.25 57 2009 1.00 2.00 1.14 60 Profitability Dillard’s Gross Profit Margin EBITDA Margin EBIT Margin Net Profit Margin Return on Equity Return on Assets Competitors Gross Profit Margin EBITDA Margin EBIT Margin Net Profit Margin Return on Equity Return on Assets Average 34.10% 7.01% 0.33% 1.64% 4.96% 2.31% DDS 2009 34.11% 6.77% 1.36% 1.10% 2.97% 1.49% 2009 34.11% 6.77% 1.36% 1.10% 2.97% 1.49% 2008 30.92% nm nm nm nm nm 2007 35.06% 6.12% 0.82% 0.73% 2.14% 1.01% JCP 39.36% 6.60% 3.78% 1.43% 5.27% 2.00% 2006 35.57% 8.23% 3.25% 3.15% 9.52% 4.55% M 40.51% 5.02% 4.53% 1.49% 7.42% 1.64% 2005 34.84% 6.93% 1.63% 1.58% 5.19% 2.20% SKS 35.97% n/a 3.71% 2.34% 5.73% 3.40% Industry Median 35.97% n/a 3.71% 2.34% 5.08% 3.40% Dillard’s profitability ratios have been beat up in recent years. In 2009, almost all of their margins were below the industry median. We believe bad management decisions in previous years is the main driver of the poor ratios. DDS was particularly hurt in 2008 when it had a negative operating profit. However, the chart below shows Dillard’s 2010 projected margins are expected to increase dramatically. We attribute this to key new managers at Dillard’s as a result of the proxy battle. 21 Dillard’s Forward Gross Profit Margin EBITDA Margin EBIT Margin Net Profit Margin Return on Equity Return on Assets 2011 36.50% 8.90% 3.54% 2.27% 6.28% 3.25% 2010 36.47% 7.31% 2.89% 1.90% 5.50% 2.75% 2009 34.11% 6.77% 1.36% 1.10% 2.97% 1.49% Industry Specific Dillard’s Sales per Square Foot Comparable Store Sales Number of Stores Competitors Sales per Square Foot Same Store Sales Number of Stores DDS 2009 110 (10.0%) 309 Average 121 (7.67%) 317 2009 110 (10.0%) 309 2008 124 (7.0%) 315 JCP 149 (6.3%) 1,108 2007 128 (6.0%) 326 M n/a (5.3%) 850 SKS n/a (14.7%) 108 Industry Median n/a n/a n/a Dillard’s industry specific ratios have not been strong over the past few years. Dillard’s has closed about five percent of its worst performing stores since 2007. Dillard’s same store sales decreased dramatically in 2009, but not as badly as higher end retail stores such as Saks Fifth Avenue. Dillard’s poor use of assets can be seen again in their low sales per square foot. Market Multiples Dillard’s* TEV/Revenue TEV/EBITDA Price/EPS Price/Book Value Competitors* TEV/Revenue TEV/EBITDA Price/EPS Price/Book Value Average 0.39 6.55 21.55 0.69 DDS 2009 0.27 9.47 nm 0.33 2009 0.27 9.47 nm 0.33 2008 0.31 5.52 38.63 0.38 2007 0.46 5.75 11.36 0.90 JCP 0.48 6.85 23.45 1.61 2006 0.46 5.96 15.91 0.98 M 0.66 6.34 nm 1.66 2005 0.43 6.06 20.52 0.85 SKS 0.57 nm nm 0.91 Industry Median 0.8 9.8 20.8 2.0 Because Dillard’s is a cyclical business, its market multiples vary dramatically over the past several years. DDS’ price to book value is especially low; the main driver of this low ratio is recent share 22 buy backs. Since 2005, DDS has bought back $400 million in shares. Treasury stock is accounted for on the balance sheet at par value. Note: Market multiples for Dillard’s and their competitors were taken from Capital IQ; market multiples are calculated calendar year, not fiscal year. Industry market multiple medians were also taken from Capital IQ, as opposed to Hoover’s like the rest of the industry ratio medians. Dillard’s Forward Price/EPS Price/Book Value 2011 18.08 1.14 2010 17.21 0.96 2009 nm 0.33 DuPont Analysis Dillard’s Net Profit Margin Total Asset Turnover Equity Multiplier Return on Equity Competitors Net Profit Margin Total Asset Turnover Equity Multiplier Return on Equity Average 1.64% 1.41 2.14 4.96% DDS 2009 1.10% 1.35 2.00 2.97% 2009 1.10% 1.35 2.00 2.97% 2008 nm 1.47 2.11 nm 2007 0.73% 1.38 2.12 2.14% JCP 1.43% 1.40 2.63 5.27% 2006 3.15% 1.45 2.09 9.52% M 1.49% 1.10 4.53 7.42% 2005 1.58% 1.39 2.36 5.19% SKS 2.34% 1.23 1.99 5.73% Industry Median 2.34% 1.40 1.55 5.08% Key Takeaways: Ratios   Historic ratios further support the cyclicality of DDS Management team performed badly over the past few years (turnaround candidate) o Poor asset management o Low 2009 margins o Low sales per square foot Projected 2010 ratios look very promising o Higher margins o Decreased debt o Return on equity doubles  23 PRO FORMA INCOME STATEMENT In order to project the 2011 pro forma income statement, we first projected the second half of 2010 income statement. We based second half fiscal year 2010 estimates on the first half actual number from DDS’ most recent 10-Q. Because retail is a seasonal industry, we could not simply multiply revenues by two to get the full year’s projected revenues. Instead, a ten year average was taken of the percentage of first half sales to total year’s sales. The ten year average of first half fiscal year sales to total year’s sales is 45.5%. We adjusted this figure modestly to 45% in our projected 2010 revenues because we are expecting a stronger second half of this year. Consumer confidence has risen in the second half of the year as the U.S. slowly climbs out of the worst recession since the Great Depression. For costs of goods sold, we assumed COGS as a percentage of revenues to stay the same for the second half of 2010 as it was for the first half. We carried this assumption for all of the remaining costs, operating expenses, and other expenses down the income statement. We then used our 2010 full year income statement to base our fully projected 2011 pro forma income statement. We started top line with revenues. We looked at a multitude of factors to project revenues for 2011. We first started with two broad overviews: GDP growth and consumer spending growth. Based on our report, these figures were in a window of two to four percent. Because Dillard’s is a cyclical company, their revenue growth is tied very closely to the growth in GDP (as mentioned earlier in this report). Another good benchmark statistic to project revenues off of is retail store sales change. Barron’s reported the most recent (September 2010) retail sales change year to year data is an increase in 7.34 percent. Also, in the same period, personal income increased by 3.54 percent. The final broad economic indicator we looked at was consumer confidence. Barron’s most recent data (October 2010) on the change in consumer confidence is an increase of 3.08 percent. All these economic indicators provided useful insight to the growth in Dillard’s revenues. 24 We then shifted gears to a more company-focused analysis, thinking about where we expected Dillard’s growth to go. Dillard’s has very inconsistent revenue growth because of its cyclical nature. We analyzed their growth trends during the previous business cycle to get a better understanding about how revenues would change during this business cycle. The worst year of the last recession was 2002, followed by sluggish growth in 2003, and strong growth in 2004. The worst year of our most recent recession was 2009. We are projecting 2010 GDP growth to be quite sluggish as we move slowly out the recession. Historical evidence then tells us that 2011 should have stronger GDP growth, similar to 2004. In 2004, Dillard’s revenues decreased 93 basis points. This figure was another key data point in projecting 2011 revenues. Finally, we applied qualitative analysis to offer insight into projected revenues growth. We are quite bullish about the four new board members to provide a turnaround strategy for DDS. We also like Dillard’s new positioning strategy—higher end than JC Penny’s but less expensive than Saks. We believe this area of retail will do particularly well as the U.S. cautiously moves out of the recession. Taking macroeconomic indicators, company level fundamental analysis, and qualitative assessments into account, we arrived at our pessimistic, most likely, and optimistic revenue growth estimates of negative two, positive two, and four percent respectively. For cost of goods sold, the largest expense for most any retailer, we looked at the ten year average and recent trends. The ten year average cost of goods sold as a percentage of revenues is 65.5 percent. However, after looking at recent trends, we concluded the ten year average was irrelevant. More important was the recent impact of the Great Recession. From 2008 to the first half of 2010, cost of goods sold per revenue decreased by 5.5 percent. It is clear management is taking substantial actions Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 GDP 6.13 % 4.69 % 3.28 % 3.71 % 6.51 % 6.75 % 6.49 % 4.64 % 4.19 % -1.39 % DDS Revenues -1.27 % -4.81 % -2.99 % -3.95 % -0.93 % 0.31 % 1.12 % -5.61 % -5.23 % -9.91 % 25 in decreasing COGS. Because of this, we used the most recent 2010 cost of goods sold as a percentage of revenue figure (63.5%). For the remaining costs, operating expenses, and other costs, we either used five year averages or specific guidance from the most recent 10-K whenever available. Dillard's Pro Forma Income Statement Forecasted 2011 Pessimistic Most Likely Optimistic -2.0% 2.0% 4.0% $6,394,116.81 $6,655,101.17 $6,785,593.35 $4,060,264.17 $4,225,989.24 $4,308,851.78 2,333,853 2,429,112 2,476,742 2010* $6,524,609 4,145,387 2,379,222 Revenue Growth Revenues Cost of Goods Sold Gross Profit Cost and operating expenses: Advertising, SG&A Depreciation & Amortization Rentals Interest & Debt expense, net Gain/loss on disposal of Assets Asset impairment & store closing charges Total cost and operating expenses EBITDA EBT Income tax expense (benefit) Equity in (losses) earnings of joint ventures Cumulative effect of accounting change Net income (loss) Earnings per share Shares Outstanding $1,707,229.19 $1,776,912.01 $1,811,753.42 $262,158.79 $272,859.15 $278,209.33 $57,547.05 $59,895.91 $61,070.34 83,861 83,861 83,861 2,110,796 569,076 223,057 80,300 2,193,528 592,304 235,584 84,810 2,234,894 603,918 241,848 87,065 1,765,609 260,000 56,083 83,861 (8,069) 4,962 2,190,471 476,776 188,752 60,764 0 0 0 (4,333) 142,756 $2.08 68,550,106 150,774 $2.20 68,550,106 154,783 $2.26 68,550,106 123,655 $1.80 68,550,106 Note: EBIT Margins were excluded because DDS does not separate Interest and Debt expense 26 DDS Common Size Pro Forma Income Statement Forecasted 2011 Most Pessimistic Likely Optimistic 100.0% 100.0% 100.0% 63.5% 63.5% 63.5% 0.0% 36.5% 36.5% 36.5% 0.0% 0.0% 26.7% 26.7% 26.7% 4.1% 4.1% 4.1% 0.9% 0.9% 0.9% 1.3% 1.3% 1.2% 33.0% 33.0% 32.9% 8.9% 3.5% 1.3% 8.9% 3.5% 1.3% 8.9% 3.6% 1.3% Revenues Cost of Goods Sold Gross Profit Cost and operating expenses: Advertising, SG&A Depreciation & Amortization Rentals Interest & Debt expense, net Gain/loss on disposal of Assets Asset impairment & store closing charges Total cost and operating expenses EBITDA Earnings before interest & tax Income tax expense (benefit) Equity in (losses) earnings of joint ventures Cumulative effect of accounting change Net income (loss) 2010* 100.0% 63.5% 36.5% 2009 100.0% 65.9% 34.1% 27.1% 4.4% 0.9% 1.3% -0.1% 0.1% 33.6% 7.3% 2.9% 0.9% -0.1% 0.0% 26.4% 4.2% 0.9% 1.2% -0.1% 0.0% 32.7% 6.8% 1.4% 0.2% -0.1% 0.0% 1.1% 2.2% 2.3% 2.3% 1.9% PRO FORMA BALANCE SHEET We calculated a Pro Forma Balance sheet for 2010 and 2011. To do this, we used our ‘most likely’ pro forma income statements for 2010 and 2011. We made the following ratio assumptions based on historical averages in order to project the future balance sheet:   Accounts Receivable: 4.155 days Accounts Payable: 57.31 days 27  Average Days Inventory: 123.01 Accumulated depreciation was found by subtracting that year’s depreciation expense from the accumulated depreciation on the balance sheet of the previous year. For 2010, we used the 10-Q published by Dillard’s that had the Balance Sheet as of Oct 31, 2010 and estimated the remainder of the year based on that. For 2011, we compared the trends of the accounts on the balance sheet over time and estimated based on those trends. We used the pro forma balance sheet, along with the pro forma income statements, to calculate forward looking ratios (shown earlier in the report). DDS PRO FORMA BALANCE SHEET Projected 2011 2010 ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Merchandise inventory Income tax receivable Other current assets Total current assets Long Term Assets Land and Land improvements Buildings and leasehold improvements Furniture, fixtures, and equipment Buildings under construction Buildings & equipment under capital leases Less accumlated depreciation & amortization Total Long-term Assets Goodwill Other Assets Total assets Actual 2009 $529,873 75,759 1,424,216 88 43,801 2,073,737 $435,783 74,273 1,397,052 111 43,885 1,951,104 $341,693 63,222 1,300,680 217 43,717 1,749,529 72,712 2,606,963 1,300,500 50,000 29,144 (1,564,228) 2,495,091 0 65,087 4,633,915 70,343 73,844 2,870,000 3,094,048 1,355,530 1,621,430 50,000 54,759 30,844 33,844 (1,837,088) (2,097,088) 2,539,629 2,780,837 0 68,087 4,490,733 0 75,961 4,606,327 28 LIABILITIES AND STOCKHOLDERS EQUITY Current liabilities: Accounts payable and accrued expenses Current portion of long-term debt Current portion of capital lease obligations Other short-term borrowings Income taxes including current deferred taxes Total current liabilities Long-term debt Capital Lease Obligations Other Liabilities Deferred income taxes Subordinated debentures Total Liabilities Common Stock Additional paid-in capital Accumulated other comprehensive loss Retained earnings Less treasury stock, at cost Total stockholders equity Total liabilities and stockholders equity 663,538 1,700 898 0 79,800 745,936 745,810 12,000 216,753 313,943 200,000 2,234,442 1,211 785,404 (21,822) 2,758,876 (1,124,196) 2,399,473 4,633,915 650,882 1,758 1,000 0 81,993 735,633 746,698 12,000 215,876 331,350 200,000 2,241,557 1,211 785,404 (21,346) 2,608,102 (1,124,196) 2,249,175 4,490,733 676,501 1,719 1,775 0 89,027 769,022 747,587 22,422 213,471 349,722 200,000 2,302,224 1,209 782,746 (22,298) 2,484,447 (942,001) 2,304,103 4,606,327 VALUATION In order to value Dillard’s stock, we performed two relative valuations: price to earnings and price to sales. For the price to earnings valuation, we started with our projected earnings per share from our pro forma income statement for the three cases, pessimistic, optimistic, and most likely. In order to find the appropriate P/E multiples to apply to our earnings, we first look at DDS’ historical P/E multiples. Like we did in our pro forma to project revenues, we concluded 2004 to be the most similar year to 2011 in terms of the business cycle. DDS’ P/E in 2004 was 59.34x, about four times Dillard’s current P/E. Thus, 29 the 2004 historical P/E multiple seems a bit unreasonable for 2011. However, 2005 and 2006 had revenue growths (0.31% and 1.12% respectively) that are very close to our most likely 2011 revenue growth (2%). The P/E multiples for 2005 and 2006 (20.52x and 15.91x) appear to be more reasonable for 2011 projections. Because of this, we took an average of 2005 and 2006, 18.22x, to use for most likely scenario multiple. Relevant P/E multiples Recent 14.32 2009 nm 2008 38.63 2007 11.16 2006 15.91 2005 20.52 2004 59.34 2003 17.69 2002 34.90 2001 24.09 SKS Recent nm 2000 9.60 DDS DDS 2000-2009 Average 25.76 Oct 2010 Industry Median 20.9 JCP Recent 26.24 M Recent 17.93 Note: Recent P/E multiples taken from Yahoo! Finance, historic P/E multiples taken from Capital IQ Another notable P/E multiple we considered was the retail industry median of 20.9x. Because we believe Dillard’s is a turnaround, it is not extremely likely DDS will trade at the industry average in 2011. Thus, we used applied the industry median of 20.9x to our optimistic scenario. For our pessimistic case, we wanted to be as conservative as possible. Our pessimistic case involves the economy not rebounding at the rate we are projecting for 2011. Such was the case in 2007 when GDP growth rate decrease by about 180 basis points from the previous year. DDS’ P/E multiple in 2007 is the lowest in the previous eight years. Cyclical stocks are difficult to predict multiples because of their volatility. Thus, we feel confident using the lowest P/E multiple from the previous eight years of 11.16x for our pessimistic case. 30 P/E Valuation 2010 EPS P/E Price Weight Weighted Average 11/05/10 Close Price Margin of Safety $1.80 17 $30.67 1 $30.67 28.46 7.8% Pessimistic $2.08 11.16 $23.24 0.25 2011 Most Likely $2.20 18.22 $40.07 0.5 $37.65 28.46 32.3% Optimistic $2.26 20.9 $47.19 0.25 The second valuation we performed was a price to sales multiples. This valuation was slightly more challenging to project the multiples for because DDS historical P/S multiples were unavailable. However, we do have several peer company multiples and an industry median multiple. Like the P/E valuation, we applied the industry median (0.45x) price to sales multiple to our optimistic case. Based on our evaluation of DDS’ growth, we concluded 2011’s growth will most likely be better than 2010’s growth. For our most likely case, we took an average of the DDS’ recent P/S multiple and the industry median P/S multiple (0.37). Our biggest challenge came in providing a pessimistic P/S multiple. The peer average P/S multiple was not relevant for two reasons: 1) four out of five of DDS’ top competitors have P/S multiples above the industry average and 2) Dillard’s is currently performing worse than its competitors. Thus, to project the P/S multiple for our pessimistic case, we subtracted from our most likely case by the same amount as the difference between our optimistic and most likely case. Relevant P/S Multiples DDS Recent 0.33 Industry Median 0.45 SKS (Saks) 0.72 M (Macy’s) 0.45 JCP (JC Penny’s) 0.44 KSS (Kohl’s) 0.92 JWN (Nordstrom’s) 1.01 Note: Recent P/S multiples taken from Yahoo! Finance; Industry median taken from Hoovers 31 Price/Sales Valuation 2010 Sales Shares Outstanding Sales/share P/S Price Weight Weighted Average 11/05/10 Close Price Margin of Safety 6,524,609 68,550,107 $95.18 0.33 $31.41 1 $31.41 28.46 10.4% Pessimistic 6,394,117 68,550,105 66,050,105 $93.28 0.30 $27.98 0.2 2011 Most Likely 6,655,101 68,550,106 66,050,106 $97.08 0.37 $35.92 0.6 $35.86 28.46 26.0% Optimistic 6,785,593 68,550,107 66,050,107 $98.99 0.44 $43.55 0.2 Because we were less confident in projecting the P/S multiples, we decided to put a slightly higher weighted average on the P/E valuation. P/E Valuation Price P/S Valuation Price Weighted Average 11/05/10 Close Price Margin of Safety 2011 $37.65 $35.86 $36.93 Weight 0.6 0.4 28.46 29.77% 32 Recommendation Buy 2,200 shares of DDS at net asset value of $62,612. Conclusion  Dillard’s is a cyclical stock, we believe the economy has bottomed out and we expect economic growth to fuel grow in DDS  We are particularly bullish about the retail industry, feeling it will be a leading industry of economic growth  Dillard’s was especially beat up by the recession making it a strong turnaround candidate  As part of their turnaround, Dillard’s has dramatically cut costs, replaced four board members, and changed their positioning strategy. 33 APPENDIX CONSOLIDATED BALANCE SHEETS Dollars in Thousands January 30, 2010 January 31, 2009 Assets Current assets: Cash and cash equivalents Accounts receivable, net Merchandise inventories Federal income tax receivable Other current assets Total current assets Property and equipment: Land and land improvements Buildings and leasehold improvements Furniture, fixtures and equipment Buildings under construction Buildings and equipment under capital leases Less accumulated depreciation and amortization Other assets Total assets Liabilities and stockholders' equity Current liabilities: Trade accounts payable and accrued expenses Current portion of long-term debt Current portion of capital lease obligations Other short-term borrowings Federal and state income taxes including current deferred taxes Total current liabilities Long-term debt Capital lease obligations Other liabilities Deferred income taxes Subordinated debentures Operating leases and commitments Stockholders' equity: Common stock, Class A—116,937,769 and 116,560,308 shares issued; 69,821,021 and 69,443,560 shares outstanding Common stock, Class B (convertible)—4,010,929 shares issued and outstanding Additional paid-in capital Accumulated other comprehensive loss Retained earnings Less treasury stock, at cost, Class A—47,116,748 shares Total stockholders' equity Total liabilities and stockholders' equity $ 341,693 $ 96,823 63,222 87,998 1,300,680 1,374,394 217 74,415 43,717 53,125 1,749,529 1,686,755 73,844 73,948 3,094,048 3,114,503 1,621,430 1,843,399 54,759 2,941 33,844 40,820 (2,097,088) (2,102,460) 2,780,837 2,973,151 75,961 85,938 $ 4,606,327 $ 4,745,844 $ 676,501 $ 1,719 1,775 — 89,027 769,022 747,587 22,422 213,471 349,722 200,000 642,940 25,535 1,704 200,000 43,486 913,665 757,689 24,116 220,911 378,348 200,000 1,169 40 782,746 (22,298) 2,484,447 (942,001) 2,304,103 $ 4,606,327 $ 1,166 40 781,055 (16,872) 2,427,727 (942,001) 2,251,115 4,745,844 34 CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended January 31, 2009 Dollars in Thousands, Except Per Share Data January 30, 2010 February 2, 2008 Net sales Service charges and other income $6,094,948 $6,830,543 $7,207,417 131,680 157,897 163,389 6,226,628 6,988,440 7,370,806 4,102,892 4,827,769 4,786,655 1,644,091 1,932,732 2,065,288 262,877 284,287 298,927 58,363 61,481 59,987 74,003 88,821 91,556 (3,207) (24,567) (12,625) 3,084 197,922 20,500 84,525 (380,005) 12,690 (140,520) (3,304) (1,580) 68,531 $ (241,065)$ 60,518 13,010 6,253 53,761 Cost of sales Advertising, selling, administrative and general expenses Depreciation and amortization Rentals Interest and debt expense, net Gain on disposal of assets Asset impairment and store closing charges Income (loss) before income taxes and equity in (losses) earnings of joint ventures Income taxes (benefit) Equity in (losses) earnings of joint ventures Net income (loss) Earnings (loss) per common share: Basic Diluted $ $ 0.93 $ 0.93 (3.25)$ (3.25) 0.69 0.68 35 CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended January 30, January 31, February 2, 2010 2009 2008 Dollars in Thousands Operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization of property and deferred financing cost Deferred income taxes (Gain) loss on disposal of property and equipment Asset impairment and store closing charges Gain on repurchase of debt Loss on disposal of hurricane assets Gain from hurricane insurance proceeds Proceeds from hurricane insurance Share-based compensation Excess tax benefits from share-based compensation Changes in operating assets and liabilities: Decrease (increase) in accounts receivable Decrease (increase) in merchandise inventories Decrease (increase) in federal income tax receivable Decrease (increase) in other current assets Decrease (increase) in other assets Increase (decrease) in trade accounts payable and accrued expenses and other liabilities Increase (decrease) in income taxes payable Net cash provided by operating activities Investing activities: Purchase of property and equipment Proceeds from disposal of property and equipment Acquisition, net of cash acquired Proceeds from hurricane insurance Net cash used in investing activities Financing activities: Principal payments on long-term debt and capital lease obligations Cash dividends paid (Decrease) increase in short-term borrowings Purchase of treasury stock Payment on line of credit fees and expenses Proceeds from issuance of common stock Excess tax benefits from share-based compensation Net cash used in financing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Non-cash transactions: Accrued (prepaid) capital expenditures Stock awards Property and equipment financed by note payable Sale of property financed by note receivable $ 68,531 $(241,065)$ 53,761 264,763 286,184 300,859 (35,350) (57,652) (2,399) (3,207) (24,567) 1,484 3,084 197,922 20,500 (1,653) — — — 3,921 — — — (18,181) — — 5,881 — 17 77 — — (325) 24,776 73,714 74,198 9,408 8,224 (4,256) 404,203 (74,415) 5,361 12,005 (372) (7,129) — (7,366) (4,243) 15,254 (163,796) (40,401) 52,265 6,143 (47,697) 554,007 350,005 254,449 (75,089) (189,579) (396,337) 11,636 67,068 48,249 — 4,320 — — — 16,101 (63,453) (118,191) (331,987) (33,888) (199,492) (104,291) (11,796) (11,898) (12,492) (200,000) 5,000 195,000 — (17,441) (111,592) — (72) (522) — — 6,028 — — 325 (245,684) (223,903) (27,544) 244,870 7,911 (105,082) 96,823 88,912 193,994 $ 341,693 $ 96,823 $ 88,912 $ 6,592 $ (1,706)$ 1,694 2,052 — 23,573 — 1,255 (516) — — — 36 37