Updated from 10:03 a.m. EDT

The retail turnaround has bypassed

Dillard's

(DDS) - Get Report

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The Little Rock, Ark., department store chain posted a second-quarter loss Wednesday on lower same-store and overall sales. Dillard's said it faced significant gross margin pressure in the period as it struggled to control rising inventory levels though markdowns. In a conference call with shareholders and analysts, the company made no bones about the disappointing quarter but said that closely monitoring the third quarter will help it identify ways to boost sales.

"This is about as bad a quarter as you can have," CFO James Freeman said on the call.

Dillard's lost $50.4 million, or 60 cents a share, in the quarter ended Aug. 2, compared with earnings of $6.7 million, or 8 cents a share, last year. Dillard's said that during the quarter it recorded a charge of 13 cents a share for asset impairments and store closings as well as a debt buyback charge of 12 cents a share.

Excluding items, the company lost 35 cents a share, compared with earnings of 14 cents a share in the year-ago quarter. Analysts polled by Thomson First Call were expecting a loss of 18 cents a share.

The shares fell $1.34, or 8%, to $15.58.

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Sales fell to $1.7 billion from $1.8 billion in the prior-year period. They were strongest in cosmetics and accessories, shoes and lingerie, and weak in home products and men's and children's lines. Comparable-store sales dropped 5%; on a monthly basis, same-store sales fell 1% in July, 6% in June and 7% in May.

In terms of sales categories, "It's difficult to point to anything that you might consider a fabulous success," Freeman said. "The men's business historically has been one that has taken it in the chin in times of economic difficulty, and I don't think there's an exception here."

Inventory at Aug. 2 was up 3% compared with last year. This was better than the 5% increase at the end of the first quarter, however. "We would be a lot happier if we were not up that 3%," Freeman said. "There's just so much you can do if you have a sales miss as much as what we had in May, June and in this quarter."

Additionally, the company said it closed three underperforming stores during the quarter as part of an ongoing program, and said it will "aggressively" continue to close stores that are not producing. Dillard's currently owns 78% of it 329 total stores and said it closed six underperforming stores already in 2003 and plans on closing two more.

Dillard's portrayed itself as proactive in trying to stanch the bleeding. The company said it's testing direct mail promotions in fashion magazines, in addition to its traditional newspaper advertising. And within its current newspaper advertising, the company is moving toward fashion-oriented ads in order to entice potential customers, Freeman noted.

The company also plans to improve its fashion clothing content, especially in its spring line. Freeman said Dillard's will reduce the amount of duplication in clothing style assortments it offers in order to "present the best ones in more depth and quantity."

Dillard's does not give forward earnings guidance, but J.P. Morgan analyst Shari Schwartzman Eberts said in a research note: "We expect our estimates to move lower as inventory levels appear high at the end of the quarter, which should keep margins under pressure in the third quarter."

Eberts, who has a neutral rating on the company, currently sees a loss of 11 cents a share for the third quarter. The company lost 7 cents a share in the third quarter last year.

On the third quarter, Freeman outlined a familiar scenario: "If we have a major miss on sales, we would have to anticipate that we would see gross margin pressure because we would respond by marking down goods and trying to control inventory levels."

Bernard Sosnick, an analyst at Fahnestock & Co., believes that the company is moving toward a "financial abyss." He said in a research note: "If sales continue to slide the company could conceivably report a loss for the full year."

Sosnick noted that the Dillard family, which controls the company, has not shown a desire to sell it, but he believes the family would sell rather than file for bankruptcy.