諾德斯特龍百貨 (JWN) 2003 Q1 法說會逐字稿

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  • Operator

  • Hello and welcome to the Nordstrom first quarter 2003 earnings release conference call.

  • All lines will be in a listen-only mode until the formal question and answer session.

  • If you would like to ask a question, simply press star 1.

  • At the request of Nordstrom, today's conference call is being recorded.

  • I would like to turn the conference over to Ms. Stephanie Allen, Manager of Investor Relations for Nordstrom.

  • Ms. Allen you may begin.

  • Stephanie Allen - Manager of IR

  • Thanks John.

  • Good afternoon everyone and thank you for joining us on the call today.

  • On the line with me are Blake Nordstrom, President of Nordstrom Inc.

  • Pete Nordstrom, President of Full Line Stores and Mike Koppel, EVP and Chief Financial Officer.

  • This afternoon Mike will lead off with first quarter results, Blake will make a few remarks and we'll open it up for questions.

  • Please note that any remarks we make should be considered in conjunction with the cautionary statements in our SEC filings.

  • Now, I'll turn the call over to Mike.

  • Mike Koppel - EVP and CFO

  • Thanks Stephanie and good afternoon everyone.

  • For the first quarter 2003, we reported earnings of 20 cents per share on a diluted basis compared to a net loss of 18 cents per share in the first quarter of last year.

  • Last year's first quarter net loss includes non-recurring and impairment charges of approximately $55m net of tax, or 41 cents per share.

  • Excluding these charges, 2002 Q1 earnings per share were 22 cents.

  • The 10.8% decrease in year over year earnings was primarily the result of below plan sales and higher than expected mark-downs.

  • At this point, I'd like to address the specific differences in our most recent guidance of 12 to 15 cents per share, versus our actual results of 20 cents.

  • The magnitude of the difference is not acceptable and we are vigorously addressing the causes so we can improve the accuracy of our projections.

  • Our margin results were approximately $11m or 80 basis points better than expected primarily due to two factors.

  • Approximately $5m of the $11m relates to the accounting for freight in our new inventory stock ledger which we implemented in February.

  • In April, we realized that our freight expense was overstated.

  • We did not include an estimate for any correction in our forecast as we did not at that point understand the range of impact.

  • As part of our closing and reconciliation process, our analysis concluded that freight expense had been overstated by $5m or approximately 40 basis points to our gross margin.

  • This is clearly an issue that we should have identified and corrected earlier in the quarter.

  • We have gone back and corrected an in-depth validation of all data and we are confident that this is a one time event.

  • The remaining $6m variance was due to better than anticipated April gross margin results in all four of our retail operations. $2m, or 20 basis points, primarily resulted from the higher than planned sales volume in our European wholesale Faconnable business.

  • This business has an historical pattern of predictable performance which prior to this quarter had not had a significant impact on total company projections.

  • We are working with our team in France to improve the timeliness of business updates to avoid future misses.

  • The remaining $4m of this was primarily due to normal variances in actual results at Rack, Full-line and Direct.

  • We continue to refine our capabilities here, but some degree of variance due to ongoing fluctuations in our mix of sales is expected and included in our range of projections.

  • With the exception of freight, the individual impact of each of these factors was small.

  • In any given quarter there are minor variances to plan from business unit to business unit which generally tend to offset each other.

  • In these instances all the variance to plan benefited margin and the collective impact was significant.

  • The forecast we use to update guidance a week and a half ago was consistent with our internal business unit projections we had seen during the month.

  • These facts and our desire to clearly communicate material changes in our expected business results led us to update guidance on May 7th.

  • We are extremely aware of the serious impact this has on our credibility with you, the investment community.

  • We are working hard to transform our company with new systems and business processes, all for the purpose of delivering improved operating performance and a high degree of transparency.

  • We are taking the necessary steps to improve the accuracy of our projections by inserting a higher degree of control into the forecasting process.

  • Now, I'd like to continue my review of our quarterly results.

  • Our gross profit for the quarter increased $32.4m and was essentially flat as a percentage of sales compared to the same quarter last year.

  • Our margin performance was primarily related to higher than planned mark-downs offset by a lower shrinkage accrual and lower buying costs.

  • The mark-down results were driven by excess inventory and competitive pricing pressure.

  • For the sake of our discussion today, the total and same-store sales details I'm about to provide will be against the 4-5-4 sales results for the first quarter of last year as we believe that will provide a more comparable basis for which to evaluate our sales performance in the first quarter of this year.

  • The corresponding GAAP numbers can be found in our press-release which is posted on our website.

  • First quarter total sales increased 3.5% to $1.3b compared to the first quarter of 2002, primarily due to the addition of nine Full-line, four Rack stores and one U.S.

  • Façonnable boutique since February the 1st, 2002.

  • Reported comp store sales decreases 1.4% for the quarter, in line with expectations.

  • Geographically, our strongest performer was the Central States region, outperforming the Full-line average.

  • Our East Coast and Northwest were in line with the average and the Southwest was slightly below.

  • Our strongest performing merchandises divisions for the quarter were Cosmetics, Accessories, Women Designer Apparel - each out performing the average.

  • Shoes, Men's Apparel, Women's Active Wear, and Women's Bridge Apparel were in line with the company average.

  • Our weakest divisions were Women's Better and Special Sizes.

  • First quarter SG&A dollars were better than planned although 70 basis points worse than last year, primarily due to negative leverage on below plan sales the full impact of which was partially offset by below plan spending related to selling cost and technology.

  • The $40m dollar increase compared to the prior year resulted from planned incremental spending related to new stores, employee benefits and sales promotion, partially offset by lower technology expenses.

  • Because of the highly fixed nature of this incremental expense, our ability to flex expenses during the quarter in response to the soft sales environment was somewhat limited.

  • Identifying and pursuing expense savings opportunities is an ongoing focus throughout the organization as reducing expenses continues to be one of our highest priorities.

  • Bad debt levels during the quarter were essentially flat with last year.

  • Delinquencies, write-off and bankruptcy trends remain stable but as always we continue to closely monitor trends and will make adjustments to our reserve as appropriate.

  • Service charge income increased approximately $2m in the first quarter, which was in line with expectations and primarily the result of higher accounts receivable.

  • Net interest expense of $20.2m was flat with last year, also according to plan.

  • Now, I'd like to spend a few minutes reviewing some of our preliminary balance sheet and cash flow results.

  • At May 3, 2003, total inventory at cost was up $84m or 8.5% from year-ago levels on a 6.5% increase in gross square footage and 7.8% increase in sales.

  • Total inventory per square foot increased 2% over last year and comp store inventory at cost increased $3.8m or 0.4%.

  • Preliminary capital expenditures for the quarter, net of developer reimbursements, totaled approximately $42.8m, primarily for new store construction and information technology investments.

  • Depreciation and amortization for the quarter was $62.8m.

  • We opened one Full-line store in Houston, Texas during the quarter.

  • There are no additional planned openings until the third quarter.

  • Preliminary total debt and total capitalization on a book basis at quarter end were approximately $1.35b and $2.74b, respectively, resulting in a total debt to cap ratio of 49.2%.

  • There was no share repurchase activity during the quarter, and we do not anticipate buying back shares in the near future as our plan to reduce our debt to total cap ratio to 40% to 45% over the next few years.

  • With regard to our performance outlook for the second quarter of fiscal 2003, compared to 2002, we anticipate the following.

  • Flat same store sales.

  • We are forecasting a flat gross margin rate as we anticipate mark-down pressure to continue into the second quarter offset by the lower shrinkage accrual rate compared to last year.

  • Slight SG&A expansion due to higher benefit costs and incremental new store expenses.

  • Flat service charge and interest expense.

  • Our effective tax rate is expected to remain unchanged at 39%.

  • These assumptions yield an earnings per share range of 35 to 40 cents for the second quarter versus last year's 39 cents.

  • Excluding non recurring and impairment charges.

  • Our updated outlook for the full year is as follows, flat same store sales, flat gross margin rate and a flat SG&A rate.

  • We still expect service charge income to increase $6m to $10m and interest expense to be flat year over year.

  • Our effective tax rate for the year is also 39%.

  • These assumptions yield an updated range for the full year of $1.19 to $1.23 which compares to $1.19 in 2002 excluding nonrecurring and impairment charges.

  • Now, I'll turn the call over to Blake for closing remarks.

  • Blake Nordstrom - President

  • Thanks, Mike.

  • Before turning the call over for questions, I'd like to make a few remarks on the quarter as well as provide an update on our systems initiatives.

  • I'd like to reinforce Mike's earlier comment about our projection versus actual results.

  • Mike and I, along with our entire leadership team owns this.

  • We are working hard to deliver on the goals and expectations we communicate and as Mike said we are committed to improving the forecasting process.

  • It goes without saying that there was a challenging quarter for retail.

  • Clearly, the customer was impacted by many uncontrollable factors.

  • As a result, the selling environment was soft and competitive pressure was intense.

  • As retailers, our job is to drive business by focusing on the things within our control.

  • Which means selecting great product, providing superior service to our customers, and responding to market conditions by exercising appropriate discipline over inventory and expense.

  • This past quarter, despite soft sales, we were pleased to see our relative same store sales performance continue to outpace many of our peers.

  • We believe this is a testament to our ongoing commitment to our merchandising strategy which focuses on providing a balanced and compelling assortment of merchandise through lifestyle departments.

  • Our business works best when we stay close to the customer and provide compelling reason, through service and merchandise, for them to choose us from the wide range of concepts and channels they have available to them.

  • Ultimately, our success boils down to two factors, merchandise and people.

  • Our merchant team strength is selecting great product.

  • We work hard to stay one step ahead by identifying the next hot item or trend and always being on the lookout for new venders that will help differentiate our mix to drive meaningful volume gains.

  • Tomorrow we will hold our annual shareholders meeting.

  • During that meeting we are pleased to give recognition to our top vendors that partner with us.

  • One of these award recipients, MAK Cosmetics is a vendor we started with roughly 13 years ago in our West side store and now we are pleased to have them as a strong part of our overall vendors.

  • It is vendors like MAK who are creating a point of difference and improve the service levels in our stores.

  • Great service is something we work hard to provide every day.

  • Our salespeople are the life blood of the company.

  • The customer relationships they build and the customer insight they provide are a big part of what drives our business.

  • Inventory and expense are also within our control.

  • We felt our plans for '03 and Q1 were appropriate and conservative at the time of their inception.

  • As events unfolded throughout the quarter, it became clear they were aggressive and we took action to make adjustments.

  • We will continue to work through this, and expect continued mark-down pressure in the second quarter as we clear through excess inventory.

  • We believe we are starting to slowly demonstrate our ability to improve the top line but as an organization we have an opportunity to exhibit stronger disciplines with inventory management and expense control to be more reflective of short term changes in our business.

  • This past quarter marks the official completion of our Perpetual Inventory implementation.

  • The last stage, rollout of the new replenishment system, was completed in April.

  • We are continuing to make headway with our training efforts which will be ongoing.

  • There's a lot to learn but our merchants are engaged and there are more and more success stories every day.

  • We are developing inventory scorecards to measure performance and identify and track our progress.

  • We're still in the early stages, but we plan to continue to provide updates as meaningful progress becomes apparent.

  • Next on the systems front is our Point of Sale initiative.

  • It began rolling out new registers during the first quarter.

  • Five stores have gone live and we plan to have approximately 40 locations live by November.

  • The new registers are being well received by employees and the rollout is proceeding according to plan.

  • Despite the challenging quarter we remain optimistic about the future of the company.

  • We believe there's a large group of customers looking for a quality experience, and we are well positioned between the purely moderate retailers and the high end luxury retailers to meet that demand.

  • We remain strongly committed to the core values of our company and the initiatives that we have laid out.

  • Achieving sustained same-store sales increases, integrating new technology, and reducing expenses.

  • Now I'd like to open it up for questions.

  • Operator

  • Thank you.

  • At this time we will have the question-and-answer session.

  • If you have a question, you may press "star 1" on your telephone touch pad and if you are using speaker equipment, lift the hand set. "Star 1" if you have a question and "star 2" to cancel.

  • One moment while the questions register, please.

  • And the first question comes from Daniel Barry with Merrill Lynch.

  • Daniel Barry - Analyst

  • Good afternoon.

  • One question.

  • If you had had the POS system completely installed that you wouldn't have had this glitch in the guidance?

  • Mike Koppel - EVP and CFO

  • No, the POS had no impact on this.

  • Daniel Barry - Analyst

  • And you're still exploring just what the problem was, then?

  • Mike Koppel - EVP and CFO

  • Dan, this is Mike.

  • I think we laid out what the problem was.

  • The problem was our freight expense wasn't being accurately recorded in our new stock ledger system.

  • We have corrected it and it is behind us.

  • Daniel Barry - Analyst

  • Thank you.

  • Operator

  • Thank you.

  • The next question comes from Theresa Donahue with Newburgher.

  • Theresa Donahue - Analyst

  • The specifics of the freight charge, how was it not properly recorded and how does this relate to other areas of the company?

  • And secondly, what's your thinking on the gap between what the divisions report up to you, as their indications and what ends up coming out?

  • I mean does there need to be another layer of financial management in there or change in communication?

  • This is a huge difference, happily I guess to the upside but --

  • Mike Koppel - EVP and CFO

  • Terry, this is Mike.

  • In terms of the freight, what was happening was, the new system was actually directly charging all freight costs right to expense, rather than charging it to our cost inventory and earning it out through mark-up which is the appropriate accounting.

  • Theresa Donahue - Analyst

  • Did this have anything to do with ETA at 16 or whatever the heck it's called or --

  • Mike Koppel - EVP and CFO

  • I'm not sure I understand.

  • Theresa Donahue - Analyst

  • The change for vendor accounting?

  • Mike Koppel - EVP and CFO

  • No, had nothing to do with that.

  • We had been on the same stock ledger system for about 25 years.

  • We converted to a new one in February.

  • You know, we nailed most of the components.

  • This one, we missed.

  • And we corrected it.

  • But we did not include the impact of this in our projection.

  • Theresa Donahue - Analyst

  • Are there other categories that you know, you might still be looking at or --

  • Mike Koppel - EVP and CFO

  • The last week we have gone back and re-evaluated every component, and no, we don't see problems there.

  • And then in terms of the division, we are going to step up the rigor and review process with all the forecast we are getting from the division and get a higher level of metric score carding on this so we don't have this happen again.

  • Theresa Donahue - Analyst

  • Is it a question of not frequent enough reporting or could there be an interim management layer or is there something in their compensation structure that causes them to low-ball things?

  • Mike Koppel - EVP and CFO

  • Well, I think a piece of it is the fact that, you know, we haven't had good tools to be able to project in the past.

  • I think a piece of it is this year, first quarter, we converted to a new stock ledger system, we converted from a Gregorian to a 4-5-4 calendar.

  • There are a number of things in there.

  • We're going to move forward.

  • We own it, we made a mistake and we're going to fix it.

  • Operator

  • Thank you.

  • Next question comes from Shari Eberts with J.P. Morgan.

  • Shari Eberts - Analyst

  • Following up on that question, could you talk about any technology implementations planned for this year which may lead to other changeover similar to the freight issue?

  • Mike Koppel - EVP and CFO

  • Shari, the only thing going on now is we are rolling out our new point of sale registers.

  • And we now have five stores live on it.

  • And no, those should not impact our results the way the freight did.

  • Shari Eberts - Analyst

  • And what gives you the confidence in saying that in terms of the POS system?

  • Mike Koppel - EVP and CFO

  • Because the POS system isn't applying any calculation to data, it is capturing sales at the point of sale and feeding it into systems to use that to calculate margin.

  • Shari Eberts - Analyst

  • You mentioned on the SG&A side that your selling cost and technology were both lower than planned.

  • Could you discuss that in a little more detail?

  • Mike Koppel - EVP and CFO

  • Selling cost is a result of us flexing down or staffing in response to slower sales.

  • We target to hold selling costs as a percent of sales because we are a 100% base commission business.

  • And so as sales softened, we did respond to that.

  • The second piece in terms of technology, last year we were, you know, really in the high end of rollout of per pet perpetual.

  • That's behind us now.

  • While we do have a new point of sale initiative, this year the cost of that is less than perpetual.

  • So we are starting to see some of those savings.

  • Shari Eberts - Analyst

  • In terms of the flat guidance Q2, I'm assuming that, that is on a 4-5-4 basis or is that on a reported GAAP basis?

  • I found that quite confusing.

  • Mike Koppel - EVP and CFO

  • It is.

  • It is on a 4-5-4.

  • We are sorry for the confusion.

  • We converted this year and we may be the last person out there who has done that, but it was the right thing to do.

  • Shari Eberts - Analyst

  • So, next year will we be comparing 4-5-4 to 4-5-4?

  • Mike Koppel - EVP and CFO

  • Yes, it will be 4-5-4 to 4-5- 4 financial.

  • Now we have been doing that for sales for a year now.

  • But now that our books are on a 4-5-4 calendar, after we get through this year, we'll be 100% comparative.

  • Shari Eberts - Analyst

  • And your GAAP reporting will then change to the 454?

  • Mike Koppel - EVP and CFO

  • That is GAAP.

  • It will be the same.

  • Shari Eberts - Analyst

  • Okay.

  • Thank you.

  • Operator

  • The next question comes from Margot Asher from CSFB.

  • Margot Asher - Analyst

  • I'm calling in for Michael.

  • In the third and fourth quarters you took catch-up markdowns related to the systems implementations.

  • Where are you right now in terms of taking those mark-downs that are related to the rollout of the perpetual inventory systems?

  • Mike Koppel - EVP and CFO

  • This is Mike.

  • What they were not necessarily catch-up, what they were is some timing differences because our tools that we are using to capture mark-downs had changed.

  • We have totally anniversaried that in this first quarter.

  • So right now we are apples to apples going forward on that mark down rhythm.

  • Operator

  • Next question comes from Dorothy Lakner with CIBC World Markets.

  • Dorothy Lakner - Analyst

  • Yes, good afternoon, everyone.

  • Just going back to what Blake was saying about your Nordstrom's traditional expertise and success in merchandise and giving the right merchandise to the right customer.

  • What -- you had the best success in -- or one of the best successes in the quarter in Women's Designer -- very high price merchandise at a time when obviously the economy is not too good.

  • What can that experience or the experience that you had in Cosmetics tell you about how to improve the rest of the businesses, and to make sure that you have the right people, and you have the right merchandise in those other categories that didn't do quite as well?

  • Pete Nordstrom - President of Full-line Stores

  • This is Pete.

  • I think the thing we learned from that, it's been going on for a while now, is probably the best indicator of good business for us has a lot to do with flow and fashion and newness and designer area has done a really good job of planning their sales and inventory so they can flow in newness all the time.

  • They are not telling a price story but there is always something interesting to look at and for that customer it is compelling.

  • For cosmetics, they've done it for a few years but they not only have the newness with their product but they also do a lot of promotional events.

  • What I mean by that is activities that get the customers in there based upon the services that we provide in that arena.

  • Those combinations of factors have really given us the most success across all our merchandise divisions.

  • And we're all learning from each other on that one.

  • Dorothy Lakner - Analyst

  • It seems as if in other departments even in the shoe department I've noticed newer brands flowing in.

  • Are there other departments where you've been really active in pursuing new brands?

  • Mike Koppel - EVP and CFO

  • Yes, it's always a balance.

  • There's a core that you want to stick with that has a lot to do with items and oftentimes that's the more predictable side of the business.

  • But it's our merchants that have had the experience and the success to go with it.

  • I think everyone can really see here what's happened over the last year is that, however their departments define fashion, it's important that we have the right balance of that flowing in, in consistent level.

  • So I'm pretty confident that that's going on across all merchandise divisions or at least the intention is there.

  • Dorothy Lakner - Analyst

  • Just another follow-up question on the differences in what you were projecting and what actually happened on the European Faconnable business, is that something that we need to look out for?

  • It didn't make a huge difference in the quarter but it was nonetheless something I haven't really ever heard you talk about before.

  • Mike Koppel - EVP and CFO

  • No, and we haven't had to in the past.

  • No, I think, the issue here relies strictly in you know, the diligence and the accuracy of the way that projection was put together.

  • And what we're doing is, we're working with a team over there to build some better disciplines in order to come with more accurate forecast.

  • I don't think it is anything more complex than that, Dorothy.

  • Operator

  • Thank you and the next question comes from George Strachan with Goldman Sachs.

  • George Strachan - Analyst

  • Question about expenses which came in, in dollar terms, below expectations, but was still up considerably, and up as a percentage of sales.

  • Did I understand correctly that for the balance of the year you expect SG&A to be up only slightly and if so what accounts for the bulge in absolute dollar increase in Q1 relative to the last few quarters?

  • Mike Koppel - EVP and CFO

  • We do expect the growth and expense to contract as the year progresses.

  • And there's a couple of things going on here.

  • The first and most significant is the fact that in this quarter, we opened eight stores last year, and we opened Houston first quarter this year.

  • So we had the full impact of nine new stores this quarter.

  • And so on an absolutely level that drove up a lot of the dollars.

  • A couple other smaller items.

  • We did have an increase in sales promotion cost which is basically moved from some costs later in the year to the first quarter where we did some additional events in the first quarter.

  • And then also, the whole benefit which is primarily driven by medical which we started to see increase in third quarter last year which we're starting to see the same level of increase in 2003.

  • George Strachan - Analyst

  • So the sales promotional costs that were moved from later quarters into Q1, they should now start to subside?

  • Is that correct?

  • Mike Koppel - EVP and CFO

  • Well, for the year we're basically flat.

  • So as we move forward that range should start to narrow.

  • George Strachan - Analyst

  • Okay.

  • And then it sounded like your inventories are in relatively good shape relative to the rest of the industry.

  • But Pete, you mentioned that you did have some markdown liability.

  • I was just wondering what -- you had stable margin in the quarter, so I was just wondering what kind of mark-down risk you could perceive for the second quarter, what the content, et cetera.

  • Pete Nordstrom - President of Full-line Stores

  • I think it's fair to say we planned more aggressively than we should obviously looking back at it in retrospect now.

  • We felt like we had a chance to have decent results this first quarter based on what we were going against and the momentum we had.

  • But there were a lot of factors that came in to play and we bought up against a relatively aggressive plan and we had more than we should have.

  • We marked down more than we should have.

  • I think that we're in pretty good shape going forward but there is still some carryover effect.

  • I think the advantage we have is we get into our half-yearly event which really allows us to clean up pretty well and we use that time to keep ourselves really clean and I think we'll be able to do that.

  • But it's not a giant problem but I think it's something we need to stay on top of all the time to make sure we're in a position to be able to react what's going on out there.

  • Operator

  • Next question comes from Deborah Weinswig with Salomon Smith Barney.

  • Deborah Weinswig - Analyst

  • Mike, back in the forth quarter you had guided flat to low single digit comps, and on those comps you had also guided moderate gross profit improvement, and SG&A improvement as well.

  • So since we're still looking at flat comp guidance for the second quarter and the rest of the year what's changed on the gross margin and SG&A side since the fourth quarter?

  • Mike Koppel - EVP and CFO

  • Well, the gross profit -- we do see additional mark-downs over plan.

  • In the second quarter.

  • We just had a question, previous question regarding that our inventories were in relatively good shape.

  • But relative to our plan, we are over and our intent is to bring those down accordingly.

  • In terms of expense we are -- we're seeing a little more expense in benefits than we anticipated.

  • Everything else, though, is pretty much in line with our budget.

  • Deborah Weinswig - Analyst

  • Okay.

  • And you had said that inventory was over relative to your plan.

  • But I think on the guidance call where you kind of updated us, you said 45 days ago you looked to clear things up.

  • So wouldn't we see -- isn't there potential for gross margin improvement in the back half of the year?

  • Mike Koppel - EVP and CFO

  • Well, potentially.

  • But I'm not sure we're seeing that clearly in the future that in fact, you know, the relative business trend is such that we wont have that pressure.

  • Deborah Weinswig - Analyst

  • Okay.

  • One last question with the anniversarying of the perpetual inventory systems rollout.

  • Can you tell us how that would help the organization in terms of better forecasting in the future?

  • Mike Koppel - EVP and CFO

  • I think in terms of better forecasting, it's going to help us better understand where our inventory liabilities are.

  • In other words, where we have slow-selling inventory and where we need to take mark-downs.

  • That is the something that will evolve over time and will give us visibility into our performance.

  • It helps us to understand where inventory levels are and are on order and the ability to understand whether or not you know we're looking at an overbought position going forward.

  • So I think those are the two major areas that will help us.

  • Operator

  • Next question comes from Dana Cohen with Banc of America.

  • Dana Cohen - Analyst

  • I understand there is this freight issue, but can you walk us through one more time the accounting implications of what happened and then I guess more importantly why wasn't it -- at what point did you realize there was this issue?

  • How did it come out?

  • Mike Koppel - EVP and CFO

  • Sure Dana, this is Mike again.

  • In terms of the accounting implications, the net-net is that the freight system was applying freight cost as a direct charge to margin, rather than charging it to cost purchases, and thus the freight being rolled out as part of our markup.

  • We really got our arms around this sometime in the middle of April in terms that it was an issue.

  • We did not have the entire amount reconciled or understood the total impact, quite frankly until after we ran the stock ledger at the end of the month and went through the calculation, and that was subsequent to when we did the guidance.

  • Dana Cohen - Analyst

  • Well, I mean I guess, in hindsight, it's always easy in hindsight.

  • But should there have been alarm bells given the magnitude of the difference, the earnings shortfall was pretty big relative to sales.

  • Obviously, you didn't know where the problem was.

  • But I guess should it have -- I mean, it just seems the like something was wrong.

  • Mike Koppel - EVP and CFO

  • You know, Dana, I don't disagree with that.

  • We should have caught this earlier and we should have got our arms around it earlier.

  • And that's it.

  • Dana Cohen - Analyst

  • And with respect to inventories, where do you think they'll be at the end of the second quarter and how they'll run in the back half?

  • Mike Koppel - EVP and CFO

  • Well, at this point, I would expect our comp inventory levels to be somewhere flat.

  • They're a little bit high.

  • They're about 0.4% higher on a per square foot basis and we should see total come down a slight amount.

  • A piece of that is related to we just opened Houston in the first quarter and we tend to start with higher inventories and work our way through that.

  • Dana Cohen - Analyst

  • And then last question, you know, comps were slightly negative, the comparison in Q2 is actually more difficult than Q1.

  • Can you just talk through your thought process as to, you know, I mean obviously it's slight, but you're expecting some improvement in comp despite the tougher comparison in Q2.

  • Blake Nordstrom - President

  • Our softest quarter was the first quarter and our trend we were up 1.4 for last year, so we felt it was appropriate to have a slight gain.

  • And obviously in hindsight now looking at our first quarter, that was too aggressive.

  • But we have tried to make the necessary adjustments and we think with all the knowledge that we have today, planning flat is appropriate, even in spite of our decline last quarter, and the fact that we're going against some better improvements going forward.

  • But even though last year we had some gains, the balance of the year, if you look over a multiyear time period it's not as if we were hitting them outside of the park so we think there's upside with volume and top line growth

  • Dana Cohen - Analyst

  • But you don't think it's just being more promotional, you think there is a merchandising issue as well?

  • Blake Nordstrom - President

  • Well, from promotional we won't be undersold but we are not running any additional events.

  • It is a competitive environment but it is on our merchants having a compelling offering and with our people to drive top line sales.

  • I think we have made some small steps there in the last year, it is evident in our results and outpacing some of our competitors.

  • But as we've talked before, our business model doesn't work having decreases.

  • And we are committed to be on the plus side to be able to drive it to the bottom line.

  • Operator

  • Next question comes from Jennifer Black with Wells Fargo.

  • Jennifer Black - Analyst

  • Good afternoon.

  • I wonder if you could talk a little bit about your classics division?

  • How big it is?

  • Are you happy with the assortment?

  • And what your future plans are for Classiques?

  • Pete Nordstrom - President of Full-line Stores

  • We are not going to comment on how big it is but it is a significant part of what we have to offer.

  • And we have had success so far with Classiques.

  • We used to do more business there than we did last year.

  • It is growing back at a natural level based on the demand and I think we've made the necessary adjustments with our MPG group.

  • So we're doing better with that product.

  • So I don't know how to quite answer that other than it is going fine, at least according to plan and we're satisfied with that and we'll grow it as the customer demands that we grow it.

  • Jennifer Black - Analyst

  • Is it outperforming the other brands that are more competitive, I should say because it is a private label brand and it's a better private label brand than you said you'd had trouble in better, is it outperforming those other brands?

  • Pete Nordstrom - President of Full-line Stores

  • I don't think it actually has anything to do with it.

  • We have private label brands across a fairly wide breadth of style offerings that tends to be towards the higher end.

  • But you can't show any correlation between the price segment and the style segment they participate in and their relative success.

  • I would say Classiques have worked fairly well and I guess I don't have a specific answer for that.

  • Jennifer Black - Analyst

  • Okay.

  • Well, it's just that on the last call you had spoken and said that some of the other apparel manufacturers had hurt because of the price compression in the other department stores and that you were hurt by brand.

  • So that's why I asked the question.

  • Pete Nordstrom - President of Full-line Stores

  • That we were hurt by brand?

  • I'm sorry;

  • I don't understand what you mean.

  • Jennifer Black - Analyst

  • There were several brands mentioned.

  • Blake Nordstrom - President

  • This is Blake.

  • What was mention there is that it enhanced the mark-down pressure by the need to stay competitive, that some of our competitors were breaking sooner.

  • You were asking about performance of Classiques which is a different subject, and I think Pete's answers have been accurate.

  • Also, Pete and the others have worked hard within Individualist, -- that there is a balance to -- they have worked hard to find other branded resources to complement, and I think we think there is a healthier balance there.

  • But overall, as Pete said, Classiques continues to perform well.

  • Pete Nordstrom - President of Full-line Stores

  • And the other thing, our biggest mark-down pressure comes from not achieving our sales and inventory plans more than it does the competitive issues.

  • Clearly, that has an impact, but the bigger ones are the stuff that's within our control and that's what we're really focusing on.

  • Operator

  • Next question comes from Rob Wilson with Tiburen Research (ph).

  • Rob Wilson - Analyst

  • Was there any impact to euro's strength in your Façonnable operations this quarter?

  • Mike Koppel - EVP and CFO

  • There was a slight impact.

  • But it wasn't material to total company results.

  • Rob Wilson - Analyst

  • Okay, fair enough.

  • Your guidance for the rest of the year, would that imply a higher EBIT margin this year than last year?

  • Mike Koppel - EVP and CFO

  • Well, actually, we're forecasting somewhat flat for the rest of the year and we lost some ground in the first quarter.

  • So I think it's slightly lower.

  • Rob Wilson - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Thank you.

  • Next question comes from Christine Augustine with Bear, Stearns.

  • Christine Augustine - Analyst

  • Thank you, good afternoon everyone.

  • I wondered if you could discuss the inventory where you do have some excess.

  • Has that all been sent to the Rack and is that where the sales will actually show up in the second quarter comps?

  • Or will some of that remain at the Full-line stores for planned sales events?

  • And then my second question is regarding traffic trends.

  • In the first quarter, I was hoping you might discuss what those looked like.

  • Thank you.

  • Pete Nordstrom - President of Full-line Stores

  • Okay, this is Pete.

  • In terms of where it's going to show up it depends how old the merchandise is.

  • We don't artificially hang on to stuff for longer periods of periods of time.

  • It kind of works through our system on a pretty consistent rhythm.

  • We do have that half-yearly event that we always plan for and there are mark-downs planned for that so I don't really think that that's going to translate itself directly in the Full-line stores.

  • Again it is the similar rhythm.

  • We have had pretty decent sales, we've had probably more inventory than we need, I think that's helped our top line, we have had amount to clear, I think that's helped some of our top line sales too.

  • The Racks do have more transferred Full-line merchandise than they planned and that is directly the result of us being overbought in the Full-line stores.

  • So will that impact their sales, I think it probably would, I think that's what they're hoping to have happen.

  • Our issue is to get ourselves clean and able to react without having that cascading overhead of too much inventory following us around.

  • And then the other question was about what?

  • I'm sorry.

  • Christine Augustine - Analyst

  • Oh, would you be able to discuss what the traffic trends were like for you in the first quarter?

  • Pete Nordstrom - President of Full-line Stores

  • I don't know what you mean.

  • Traffic in what way?

  • Foot traffic?

  • Christine Augustine - Analyst

  • Yes.

  • Pete Nordstrom - President of Full-line Stores

  • I think it's been pretty good.

  • Most of the centers that we're in are pretty well trafficked.

  • So I don't think there's been any focus on our part to see what we can do to generate traffic or commiserate about that.

  • I think it really continues to fall into the desirability of our product.

  • And one thing that again happens time and time again is when we have a delivery of great new product, it sells.

  • And it's not because of some gimmick or anything like that.

  • We get it out there and it performs.

  • And we've had some departments that have done that consistently well, namely Cosmetics, Designer and the Accessory division.

  • That is the one clear thing we could point to.

  • But I don't think the traffic is off in any kind of measurable way.

  • Christine Augustine - Analyst

  • Okay.

  • So it sounds like then, the reason for the soft comp was likely one of transaction size, or ticket?

  • Pete Nordstrom - President of Full-line Stores

  • That could be.

  • Mike wanted to say something I can see here.

  • Mike Koppel - EVP and CFO

  • Back in the first quarter, I think overall, on an apples to apples basis, traffic was probably comparable.

  • Other than the difficult weather, we had a number of stores closed for a number of days, and then we also saw business soften up right around the war.

  • But subsequent to that, it's come back to what has been a more normal pattern.

  • Operator

  • Thank you.

  • The next question comes from Steven Curnkraw from Burnham Capital.

  • Steven Curnkraw - Analyst

  • Could you explain this freight issue?

  • Six, seven cents of income was overstated in the 2002 results.

  • Is that all in the fourth quarter, is that spread out throughout the year?

  • Mike Koppel - EVP and CFO

  • Steve?

  • Steven Curnkraw - Analyst

  • Yes.

  • Mike Koppel - EVP and CFO

  • No, Let me clarify it.

  • This had nothing to do with 2002 results.

  • We implemented a new stock ledger in February of '03 this year, in the first quarter.

  • The reason we made the adjustment, it was a question of adjustment in our projection.

  • We had an overstatement of freight cost in February and March, and somewhat in April, in our projections.

  • We didn't understand that when we gave the projections to the street on May 5th, okay?

  • So included in the projections we gave was about $0.025 cents of understated because of this freight.

  • It had nothing to do with 2002 results.

  • Steven Curnkraw - Analyst

  • Okay, okay.

  • So it's about 2.5 cents.

  • So again, there's $0.025 cent benefit.

  • But your guidance before was $0.12 to $0.15.

  • Here it's 20 cents, right?

  • Mike Koppel - EVP and CFO

  • Yes.

  • Steven Curnkraw - Analyst

  • And where is the other $0.025 to $0.05 cents that we've benefited over the last week?

  • Mike Koppel - EVP and CFO

  • Well, the other components I talked a little bit about in my script but I'd be happy to go through those again.

  • There was about a penny as a result of our European Façonnable business that basically understated the projected sales and margin for that business.

  • And then the balance was a number of overages in terms of margin in the rest of our retail divisions to the tune of about $1m to $2m in each one of those.

  • Okay?

  • Steven Curnkraw - Analyst

  • Okay.

  • Now, you've implemented a multitude of systems in the last 12, 24 months?

  • Mike Koppel - EVP and CFO

  • Yes, we have.

  • Steven Curnkraw - Analyst

  • Okay, and they're all coming at the same time.

  • Are we perhaps going too quickly in implementing the systems and don't have our arms around it or are you collectively as a management team comfortable that this is an aberration that we're seeing this, I don't want to say restatement, but effectively that's really what it is.

  • I mean we should not expect these types of things happening in the subsequent quarters?

  • Mike Koppel - EVP and CFO

  • Well, Steve, first, let me just clarify that this is not a restatement.

  • I mean, our reported financial results for all periods are accurate.

  • This was a miss in our projection for the quarter.

  • Now, in terms of do we have too many systems going on?

  • We've got a lot going on.

  • We were way behind in terms of our technology infrastructure.

  • We've done a lot in the last couple of years.

  • You know, when we put in Perpetual, we ultimately had to put in a related to stock ledger.

  • We had to put in new financial systems to support that.

  • There was a lot.

  • Would we hope there wasn't going to be any miss?

  • Yes we do.

  • In terms of going forward, we have validated this system and are confident this is not going to give us any more surprises in related to margin.

  • Steven Curnkraw - Analyst

  • In the second quarter where you're assuming the comps are flat, okay, can you give us some better granularity in terms of what you're really expecting in the anniversary sale versus what you're expecting in the half-yearly sale?

  • Pete Nordstrom - President of Full-line Stores

  • I don't think we can give any more detail other than we've had some pretty positive momentum with our sales events over the last year or two.

  • We anticipate that that can continue.

  • There are continuous evolutions and tweaks that we make to that.

  • We'll keep doing the same things we've been doing that brought us success.

  • But we can align our business in terms of direct and how these things line up.

  • So when we start, we can start with the biggest bang we can start with.

  • Steven Curnkraw - Analyst

  • But for the half-yearly sale, you're not going to have to bring in special order merchandise for half-yearly sale?

  • Is that a fair statement?

  • Mike Koppel - EVP and CFO

  • We always bring in special merchandise too.

  • It's a balance of both.

  • Steven Curnkraw - Analyst

  • Thank you very much.

  • Operator

  • Thank you.

  • I show the next question comes from Robert Toomey from RBC.

  • Robert Toomey - Analyst

  • Can you comment a little bit on the Rack stores? their comps were down - looks like in the quarter, and they've been showing some pretty good positive comps over the past few quarters.

  • Just kind of what happened there?

  • The change there?

  • Blake Nordstrom - President

  • Bob, this is Blake.

  • A couple of factors contribute to it and like everything we do there is a balance there.

  • And there is a balance with the transfer merchandise from the Full-line stores with the merchandise they're able to buy, special purchase, from out key vendors.

  • With more merchandise coming from the Full-line stores, we've had to back off on the special purchase.

  • And they found themselves getting a little overbought as well, so that flow and that freshness and content got affected, and I think the customer responded to it a little bit.

  • That's something internal because, in our opinion, there is a lot of great merchandise available out there.

  • We wish we had more open to buy in the Rack division to be able to react appropriately.

  • But we're working through the merchandise that we do have so we can get a little more fluid.

  • Because for much of 2002, Laurie Black on our team really had that business unit humming and we fully expect to get back to that position soon.

  • Robert Toomey - Analyst

  • Okay.

  • Mike in his comments mentioned something relating to a stronger discipline, I think, in inventory management and controls, did I hear that right?

  • And can you elaborate on what he meant by that?

  • Mike Koppel - EVP and CFO

  • Well, Bob, my commentary was more around the issue of our projection, okay?

  • T what I was referring to on that.

  • Robert Toomey - Analyst

  • Okay, I thought you were referring to -- is there anything new related to inventory management or just more implementation of perpetual inventory?

  • Blake Nordstrom - President

  • This is Blake.

  • Those are my remarks.

  • There is no question from a projection point of view our company can do a better job and all of us tried to take ownership and accountability on behalf of that and we must improve there.

  • But, as well, I mentioned in my remarks that in this environment, we must strengthen our disciplines with expense management and inventory management, particularly when we get swings in our business like we experienced last quarter.

  • Anyone could have predicted all the issues that took place in Q1, but the most successful retailers are a little more agile and flexible than we've demonstrated of late in those areas and we fully expect ourselves to improve there.

  • Robert Toomey - Analyst

  • Great.

  • One last question if I might.

  • I think it was Blake or maybe it was Pete that mentioned that you had potentially some upside to your top-line growth.

  • I think that was the comment.

  • Can you elaborate on that or explain what you meant by that?

  • Blake Nordstrom - President

  • Again, Bob, this is Blake.

  • For this business model to work, we need to have productivity gains and we need to have top-line gains.

  • And so everyone is focused on that, incented on it, measured and accountable accordingly and that is our number one focus.

  • And I think we've demonstrated in the last 13 months or so some steps forward on that.

  • We need to do more.

  • There are other aspects of the business that we're working on, including merchandising, that we think can help facilitate top-line growth.

  • And so, as Pete mentioned, we have had success in the last two or three years with our half yearly anniversary events and there have been some adjustments to evolve that.

  • And so I think merchants are always guilty, and we are too, about tomorrow and being optimistic but we are trying to be mindful of the facts around this trend.

  • But we do think flat at this point is appropriate and we do think there is upside if we can execute better.

  • Because there's clearly customers in our store and there are customers looking for a quality experience out there and we want to be their store of choice.

  • Robert Toomey - Analyst

  • Great, thanks very much.

  • Stephanie Allen - Manager of IR

  • With that, I'd like to thank you all for participating in our call this afternoon.

  • If you have additional questions or need further information, you're welcome to contact me Stephanie Allen.

  • I'm the manager of investor relations and I can be reached at 206-303-3262.

  • In addition, a telephone replay of this call will be available through this coming Thursday.

  • The replay number is 1-888-568-0719.

  • There's no pass code.

  • That number again is 1-888-568-0719.

  • The webcast of this call will be archived on our website for 30 days.

  • For access, go to Nordstrom's Website at www.nordstrom.com, click on the investor relations option at the bottom of the screen, and next click on Q1 conference call link which will guide you to the audio portion of the call.

  • Thank you and good bye.

  • Operator

  • We would like to thank you for participation.

  • Enjoy the rest of your day and at this time you may disconnect.