梅西百貨 (M) 2003 Q2 法說會逐字稿

May I have your attention, please?

I'd like to thank everyone for holding and welcome you to the conference call today with your Chairperson, Karen Hoguet.

I want to remind the participants that you'll be in listen-only mode during the presentation.

Today's call is also being recorded for replay purposes.

Ms. Hoguet, thank you for using Sprint Conferencing.

I'll turn the call over to you.

Okay, thank you.

Good morning, and welcome to Federated Department Stores' Second Quarter Earnings Conference Call.

I am Karen Hoguet, CFO of the Company.

On today's call, I will first summarize the key components of our second quarter performance, I will then highlight our key planning assumptions for the second half of the year, and then I will open the call for your questions.

Any transcription or other reproduction of the statements made in this call without our consent is prohibited.

A replay of the call will be available on our website beginning approximately two hours after the call concludes.

Please refer to the Investor Relations section of our website, www.fds.com, for discussion and reconciliations of any non-GAAP financial measures discussed this morning.

We are pleased with our earnings performance in the second quarter.

Sales were a bit better than we expected, especially after the weak first quarter.

But as a result of the better sales and a strong gross margin and expense performance, our bottom-line results were considerably stronger than expected.

EPS of 64 cents a share compares to our original guidance of 50 to 55 cents and the consensus estimate of 54 cents last Thursday before we raised our guidance to 60 to 63 cents.

This compares to last year's second quarter EPS of 66 cents per share.

Store closing and consolidation costs included in this year's results were $10m, or 3 cents a share, compared to none last year.

Sales in the quarter were three billion 434 million dollars, down 1.5 percent from last year.

On a comp store basis, sales were down 1.2 percent.

We are pleased with the improvement in trend from first quarter's 5-percent comp store sales decline.

Bloomingdale's and RLG-M -- Rich's, Lazarus, Goldsmith's, Macy's -- had the strongest sales performance in the quarter, with the weakest performance experienced in Florida at Burdines.

By family of business, we were most pleased by the performance of Career Apparel, both men's and women's, big-ticket Home and Cosmetics, and we were most disappointed in our sales performance in Housewares and Kids.

Gross margin in the quarter was 41.0 percent, down .2 points from last year's 41.2 percent.

Remember that last year our gross margin in the second quarter was 2.4 points above the year before.

This gross margin performance in the second quarter is better than we had assumed due to lower-than-expected markdowns because of our good inventory position and lower shortage or shrink.

As you may recall from last year, we were positively surprised by our shortage results in the second quarter, and we were able to maintain last year's rate.

SG&A in the quarter was a billion 145 million dollars, up a little less than 1 percent over last year due entirely to the $10m of costs associated with the Rich's-Macy's integration in Atlanta.

The store closing and consolidation costs of $10m were at the low end of the $10-15m we had expected.

Excluding these costs, SG&A dollars were even with a year ago.

This is lower SG&A expense than expected due to better credit results and a long list of small, positive variances in many areas of expense.

Depreciation and amortization was $173m in the quarter versus $168m a year ago.

As a percent of sales, SG&A in the quarter was 33.3 percent, .7 points over last year, due primarily to the sales decline and then also the store closing costs that I had just mentioned.

Interest expense in the quarter was $65m, and tax expense was $79m.

Net income was $120m, as compared to $133m from continuing operations last year.

Diluted share count in the quarter was 187.2m shares, which is 16.3m shares, or 8 percent lower than last year.

EPS on a diluted basis in the quarter was 64 cents, which, as I said earlier, was well above our expected 50 to 55 cents per share, which we had raised last Thursday to 60 to 63 cents.

Cash flow in the quarter continued strong, with year-to-date cash from continuing operating activities of $719m, $163m above last year.

As you see in the balance sheet, inventory at the end of the quarter was 6 percent below last year.

Cash used by continuing investing activities was $181m, $100m favorable to last year.

So cash flow before financing was $538m versus $275m last year, again, just showing the strength of the cash flow in the first half of this year.

During the second quarter, we spent $107m to buy back 3m shares.

Year-to-date, we have bought back 7.3m shares for $227m.

We also repaid $450m of 8.5-percent debt on June 16.

At the end of the quarter, our debt-to-cap ratio net of cash was 36.9 percent versus 40.2 percent a year ago.

In summary, we were happy to see sales strengthen somewhat in the second quarter, and we were pleased with the resultant earnings in cash flow.

Our hope is that this sales trend will continue to strengthen as we go through the second half of the year.

I will now highlight our key planning assumptions for the third and fourth quarters.

Keep in mind that all forward-looking statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially from the assumptions mentioned today due to a variety of factors that affect the Company, including the risks specified in the Company's most recently filed Form 10-K and Form 10-Q.

First, sales.

For the second half of 2003, we still expect comp store sales changes of minus 1 percent to plus 1 percent, with the total store sales change slightly lower due to the closed stores.

We are expecting the third quarter sales change versus last year to be just slightly less favorable than our expectation for the fourth quarter, but basically the guidance for comp store sales for both quarters is the same at minus 1 percent to plus 1 percent.

Gross margin rate in the fall is expected to be up slightly versus a year ago, with a lower increase expected in the third quarter than in the fourth quarter.

SG&A dollars, excluding the store closing and consolidation costs, is projected to increase slightly in both the third and in the fourth quarters.

On top of this increase, SG&A will also include this fall approximately $12m of store closing and consolidation costs, with approximately $10m of this expected in the third quarter.

This estimate could be high or low by a few million dollars in the fall season.

Assuming this estimate of $12m, we will have spent approximately $30m for the year for the store closing and consolidation costs associated with the Atlanta integration.

Interest in the third and fourth quarters should be similar to that in the second quarter.

Taxes are calculated at 39.7 percent, and as you saw in our release this morning, EPS for the fall season is still expected to be $2.40 to $2.50, with 25 to 30 cents expected in the third quarter and $2.15 to $2.20 expected in the fourth quarter.

Capex for the year is now estimated at $600m to $625m rather than the $650m assumed earlier in the year due to some delays in projects.

But if you are modeling future years, you should still assume annual capex of $650m for future years.

As I mentioned a few minutes ago, we are hopeful that the change in sales trend experienced in the second quarter, combined with the increased interest in career apparel, bodes well for Federated this fall.

We continue to believe that our focus on the four priorities -- and, again, those are compelling assortments, simplified pricing, unique and more effective marketing, and a faster, easier, more comfortable shopping experience -- those four priorities we believe will continue to allow us to distinguish ourselves from our competitors in the minds of our customers and produce better comp store sales increases.

And with that, I will take your questions.

[Caller instructions.]

Our first question is from George Strachan with Goldman Sachs.

Go ahead, sir.

Thank you very much.

Karen, initially when we had the brouhaha over the Lauren line, we thought it could be a minor negative to Federated given your focus on the better categories.

But now that we have so much potential excitement there in '04 with the Lauren, the Jones signature, Anne Klein, Calvin Klein, and Tommy Hilfiger, just wondering whether you guys are looking for some more excitement either in terms of just the buzz in traffic in the malls next year or if you think that this kind of competition for floor space will create an opportunity for some worthwhile concessions for the department stores, and you, in particular?

Well, I think the easy answer, George, is we are extremely excited about the product we're seeing in the better sportswear world for next spring, and that obviously will bode very well for department stores.

As you know, we've been clamoring for this kind of focus on product, and we think it's just going to be terrific for us.

Typically, would this result in a lot of marketing dollars being spent and hopefully more traffic coming into the stores?

I don't know about the marketing dollars, George, but it will clearly draw people into the stores if the product is as good as it appears to be at this point.

Great.

Thank you.

Our next question is from Lee Backus with Buckingham Research.

Go ahead, sir.

Hey, yes, Karen, you talked -- again, congratulations, a good quarter in a tough environment.

You talked about the better area of department stores, that you thought there was excitement in that area for spring.

Could you discuss some of the other areas, maybe the more moderate area of Missy and menswear, if you see anything -- any positives in those areas?

You know, I think, obviously as a non-merchant, the area I'm hearing the most about is the better sportswear area.

I have heard some good things about some of the men's lines, which should be helpful.

I've not heard anything about the moderate arena, but that doesn't necessarily mean that there isn't something happening.

I just have not heard about it.

Okay.

Also, there was an article recently in Women's Wear Daily about some system initiatives that you're having with Liz Claiborne.

Could you discuss those or any other initiatives in that area?

Well, as you know, we've always thought there was a benefit to both us and the vendors from working closer together, and that's just one example of something going on in that arena.

But there's really nothing more specific at this point, Lee.

Okay, thank you.

Our next question is from Jeff Stein with McDonald Investments.

Go ahead, please.

Good morning, Karen.

Wondering if you might bring us up to date on the reinvent store strategy, what pieces of that strategy seem to be working the best and do customers like the best, and, you know, what pieces don't seem to matter to the customer?

You know, it's hard to really pick out piece by piece, Jeff, and from our perspective, it's sort of a total package that helps bring customers into the total store.

I can tell you anecdotally, the two areas that we hear the most about are the fitting room environments, both the improved fitting rooms themselves, as well as the seating areas outside the fitting rooms.

And the other we hear great things about is the shopping buggy, which has gotten great reviews as well, and I might add we continue to refine it and make the buggy even better.

I saw the new generation of them yesterday.

And I guess the other area I should've mentioned, also, is the wayfinding signage, which people just love.

Okay.

And could you talk a little bit about back-to-school sales?

It seems to me, based on conversations I've had with other retailers, that back-to-school's getting off to a pretty good start, and yet, you really haven't changed your expectations for the back half of the year.

Are you just being conservative, or is there something that we just don't see currently that we should be kind of aware of as we move into the fall for Federated?

I mean we, too, are excited about current sales trends, and we've been talking about the improvement at the end -- in the second quarter, which was obviously relevant as we move into the third quarter.

But we have always included an improving sales picture in the back half of the year, so we had assumed that was going to happen, and the good news is it is happening.

Now, could there be good news surprise?

I don't know.

We'll see at the end of the year.

Okay, thank you.

The next question comes from Bob Drbl with Lehman Brothers.

Good morning, Karen --

Hi, Bob.

-- [Susan][ph].

And I guess I'd like to talk maybe -- as your sales have gotten better, sort of from Q1 to Q2 and you look at the back half of the year, you mentioned sort of underperformance in Burdines and disappointment in Housewares and Kids.

Do you see anything in the back half of the year in those areas that you think could help get you over the hump here in terms of the sales?

Yes, but I don't think that that's necessarily what's going to drive the sales as we go through the fall season.

I mean it's the areas that are doing well that we think will continue to do well, and, yes, our hope will be that Housewares and Kids will be better, but that doesn't necessarily have to happen.

Okay.

I mean that is the benefit of the mix of businesses in a department store.

Right.

Okay.

And then can you maybe give us a little bit of color?

With the exposure that you have to California, there have been other companies out there talking about some pressures in California on the expense side.

Are you seeing any of that within your department store business?

Yeah, we are, worker's comp and some other employee-related issues.

But so far, we've been able to cover them, and we hope to continue to be able to do so.

One final question.

On deflationary trends within the apparel business, can you tell us sort of how that impacted the business this quarter and your expectations for the back half of the year?

Well, you know, it has mitigated somewhat, but there continues to be deflation, and we've assumed that for the remainder of the year.

Okay, thank you.

Next question comes from Filippe Goossens with CSFB.

Yes, good morning, Karen.

Congratulations.

Thank you.

I'm sure that the bondholders will be very pleased with the continued balanced approach you take versus share buybacks and debt paydowns.

Can you kind of give us a big picture in terms of how you see your optimal capital structure going forward and what you plan to do with free cash flow now that your average is in the 40-percent range?

Yeah, I mean we have said that our targeted debt-to-cap ratio is in the 40- to 45-percent range.

And with the economic environment we've been living through, we're obviously keeping it towards the lower end of that, and in fact, at the end of the second quarter, even below that.

You know, as business improves, you know, obviously that gives us more opportunity to use the cash to buy back stock further.

Okay.

The $749m that's outstanding under the current portion of debt, I presume that's sole receivables paper?

Most of it is except that there's also in that short-term debt $250m of 6.79 percent debt that's due in 2027 but is puttable next July.

Okay.

So it needs to be in short-term debt.

Yeah.

The rest of it primarily is Visa.

Okay.

And any ideas what you plan to do with debt receivables, debt paydown or refinance?

Well, it's in short-term debt now, so we just use -- I mean obviously we want to keep that debt out there and grow with the Visa portfolio.

Yeah, okay.

And then the final question, Karen, kind of a follow-up on the earlier question on California.

Are you seeing any impact in terms of sales in California because of planned tax increases in that state?

Sales, as I said, in California have been good.

Obviously not one of the best divisions and not the worst, but, you know, have been just fine this spring.

Okay, great.

Thanks very much.

The next question's from Shari Eberts with J.P. Morgan.

Thank you.

Good morning, Karen.

Hi, Shari.

I was hoping you could give us an update on the new Macy's national marketing campaign planned for the back half of the year?

Okay, what it is is actually a test in the fourth quarter in three areas -- Atlanta, New England, and San Diego.

In Atlanta, it will be obviously the hyphenated name;

Rich's-Macy's will be part of the test.

In San Diego, we will have reinvented the San Diego stores, as well as the national Macy's campaign.

And in New England, we are consciously not reinventing the stores to try to separate out the impact of the changed marketing approach from the reinvent capital.

So we'll know a lot more next spring after we see what happens.

I have the concern that it's going to take more than the fourth quarter to really read the results, you know, unless they're very positive or very negative, so my guess is next spring we'll have some sense as to how it worked.

Okay, great.

And then, also, hoping you could just comment on the promotional environment that you're seeing out there, any changes, and obviously what you're expecting from the fall?

Oh, we're really not seeing any change in the promotional environment, and as I mentioned earlier, we do expect gross margin increases in the fall season, a little bit more in the fourth than the third, but increases in both quarters.

And is that from a reduction in the promotional environment or just a comparison?

No, environment stays the same.

Okay.

And then last question, on the inventory obviously down very nicely in the quarter, what should we expect to see in terms of inventory reductions for the back half, if any?

I suspect it's going to narrow.

You know, I'm hoping that at some point, and particularly as the sales environment changes, to not continually reduce inventories.

So I think that that minus 6 percent will be less at the end of the third and the end of the fourth quarters.

Okay, great.

Thanks so much.

Our next question's from Linda Kristiansen with UBS.

Hi, Karen.

Just had one question, which is on deflation and in the spring season.

I guess in talking to people, I'm hearing more and more talk about [inaudible] as people are doing their buying for the spring season.

Is that something that you're experiencing?

You know something?

I don't know the answer to that, Linda.

I've not heard it, but that does not mean it's not the case.

Okay, thank you.

Our next question's from Wayne Hood with Prudential Financial.

Yeah, Karen, I just had two questions.

In light of the share repurchase program, what were the absolute shares outstanding in the second quarter, not the weighted average?

You mean the basic shares?

The diluted absolute shares outstanding at the end of the quarter, not the weighted.

You know what?

I don't have that in front of me. [Susan][ph] will call you back with that.

Okay.

The second question I had, is the business structurally changing so that if you look at your SG&A dollars, excluding D&A, could it remain around $4.1b or even decline from there?

Or would you expect it's still going to grow about 2 percent [inaudible]?

No, I do expect increases.

I do expect increases.

It will not stay flat.

Okay.

Thank you.

Our next question's from [Kristine Augustine][ph] with Bear, Stearns.

Hi, Karen.

Good morning.

I was hoping that you could provide an update on private brands, how are they doing versus the rest of the store and if there is any differentiation in the performance across categories?

Private brand is doing very well right now, really pretty much across the board.

The new N.C. line shipments that came in in June, July have been fabulous.

Alfani's doing well, Tasso Elba in Men's.

Hotel is a huge home run at this point in the textiles area.

Okay.

So I'm sure there's some place in there that something's not working, but by and large, our private label continues to be a huge success for us.

And is it safe to assume then that those brands are continuing to outpace national brands?

Yes.

Okay.

And, again, I suspect there might be an exception somewhere in the mix.

I just don't know of it, but by and large, absolutely.

Now, is Hotel -- that's a higher-end product, correct?

Correct.

So is that not fully distributed across the store base?

That's correct.

Okay, because I just -- I thought it was interesting that you called out Home as one of the softer areas, although that was --

No, I said Housewares.

-- not typically Housewares, right?

Textiles is doing better.

Okay.

And within Textiles, Hotel is doing extremely well.

Okay, great.

So are you -- do you think that's a possible rollout then to all doors or --?

I don't think it will hit all doors, but it will clearly roll out into more than it's in today.

Okay.

And then would you be able to give a little more color on the credit trends, just specifically what's helping you there or what are you seeing there?

It's really -- you know, it's been across the board.

Penetration has been doing well relative to what we expected.

Bad debt's doing well.

Income's doing well.

So it's really just a little bit of across the board.

Okay.

Thanks, Karen.

Next question's from Teresa Donohue with Neuberger Berman.

Good morning, Karen.

Follow-up on the SG&A question.

Could you give us an update on the leverage point?

I think you've always said it was a 2-percent comp, but is it heading down to be less than that?

I suspect it's probably less than that.

Okay.

But it's not a zero.

Oh, okay.

So, you know, again, after the last couple of years, we've cut quite a bit and have demonstrated the ability to control expense in ways that I never thought were possible.

Great.

Now, I suspect some of that is not necessarily good; as we all know, sometimes that happens.

But my guess is somewhere in the 1- to 2-percent range you'd see leverage.

Thanks.

Our next question's from Michael Exstein with Credit Suisse First Boston.

Good morning, Karen.

Hi, Michael.

A couple quick questions.

In terms of your guidance for the second half of the year, when you were talking about SG&A, is that rate or dollars?

And what are your --

Dollars.

Dollars?

And what are your assumptions for share repurchase activity during the [inaudible]?

It will continue.

We don't give an actual number as to what we're expecting to do.

Okay.

And then, finally, the inventory reduction, how much is on a comparable store basis and how much isn't, versus gross?

About a point less, so it's a little bit less than 5 percent down on a comp store basis.

Okay.

And the balance was from the store closings [inaudible] Atlanta?

Correct.

And last but not least, are any of the Lord & Taylor stores of interest to you all?

I suspect some of them are.

Okay.

Thank you.

Our next question's from Karen Young with Allstate.

Yeah, hi.

Can you please repeat your SG&A guidance?

I missed it.

Sure.

For the back half of the year, we are expecting SG&A, excluding the store closing and consolidation costs, in dollars to increase slightly in both quarters.

And then on top of that increase, there will also be about $12m of store closing and consolidations cost, with about $10m of that in the third quarter.

Okay, and the increase slightly is year over year?

Correct;

I'm sorry.

Correct.

Okay.

And then, also, I wanted to know what are you doing to kind of, I guess, stand the underperformance in Burdines and then also in the Kids' area, the children's clothing area?

Frankly, we think in Burdines it's temporary, and, you know, I suspect next quarter they won't even be mentioned is my hope.

I mean there's nothing systemic happening there;

I just think they hit a tough quarter, which does happen from time to time.

In terms of Kids, you know, that also has not been weak for that long, so I don't view it as a systemic weakness in the business.

Like in all of our other businesses, we're constantly focused on those four priorities -- improving the assortment, differentiating ourselves more, and making sure the pricing is simple and credible.

Okay.

Thank you very much.

Our next question's from Dan Jenkins with State of Wisconsin Investments.

Hi.

I had a couple questions.

First, I was kind of wondering -- I know you've talked about California a little bit already, but I was kind of curious if you've seen any impact in the quarter from Kohl's moving in there.

Is the environment more competitive?

Are there any market share changes from that, or are you seeing anything yet?

We've seen some impact but not dramatic.

Macy's West is positioned sort of a little bit above the rest of Federated except Bloomingdale's, so there's less direct overlap with Kohl's.

Plus, you have to remember, Mervyns has been out there for a long time, so Kohl's is less unique to California.

So, yes, we've seen an impact, but it has not been significant.

Okay.

And then I was curious as far as what your free cash flow going forward and debt reduction.

You know, you mentioned you had a puttable.

Do you anticipate you would refinance that, or would you use free cash flow to --?

I suspect it's going to stay out there.

Okay.

Okay, thank you.

Our next question is from Deborah Weinswig with Smith Barney.

Go ahead, please.

Good morning, Karen.

Two questions.

One, I know it's early, but can you give us any customer feedback or other feedback you've heard on the rebranding?

You know, I think the easiest way is that we've not heard anything positive or negative, which we view as good news.

Okay.

We were always concerned about the down side.

If at this point they're feeling okay about it, there's only up side to come.

And you've rebranded the credit cards in conjunction with that as well?

Yes, they just went out over the last couple of weeks.

Okay.

And then my second question, can you also give us an update for the quarter on traffic and ticket trends?

You know, I don't have that, so I can't right now, Deborah, sorry.

Okay.

Thank you very much.

All righty.

Our next question is from Dana Cohen with Bank of America.

Go ahead, please.

Hey, good morning, Karen.

On the deflation issue, just in terms of buckets of categories, with career -- with Better Career getting better -- pardon the pun -- what's holding back pricing increases?

Because if that's the higher price points getting better, you'd think it would be --

Well, I mean in terms of average unit sale --

Yeah.

-- put aside the deflation issue.

If career does better, average unit sale will go up.

And one of the negative factors that's been impacting that over the last couple of years has been a shift out of career into casual.

So the hope is that this is not only good for sales, but it's good for profitability.

So are you still seeing deflation because you haven't quite gotten to the break point where one offsets the other?

You know something?

I mean average unit sale is down slightly.

Okay.

But that's not really deflation.

I mean that's -- people tend to complicate deflation or confuse it with average unit retail.

Okay.

And in terms of the gross margin guidance, Q3, Q4, is that just a comparison issue, or is there something else (inaudible)?

No, I think it's a comparison issue.

Okay.

And then last question, on the strategy of simplicity of pricing, you know, where do you think you are in that, what is working, and what needs to be revamped there or, you know, tweaked?

Well, I think we've -- in terms of simplifying the pricing, we've made a fair amount of progress.

But on the pricing subject, I think we've just begun to scratch the surface.

I think it is a very complicated subject that will take us years to continue to work on because if you make too dramatic of a change, we're going to lose business, which we obviously don't want to do.

So, for example, now we're working on growing the everyday value program as a piece of this.

We're also in the home store reducing the comparables.

In other words, everyday prices will be much more fair and less -- you know, when you put something on sale, there'll be not a 50-percent discount; there'll be a 20-percent discount, things like that because that is what the customers want today.

So the initial price will be lower than previous?

That's correct.

Got it.

And where are you in implementing that?

It's rolling out as we speak.

Okay.

In any specific categories?

Primarily, we're starting in Housewares.

Okay.

You know, what's interesting is the competitive landscape in Home, in particular -- Home, in general, and Housewares, in particular, has changed a lot with the advent of Bed, Bath and Beyond and Linens 'n Things and people like that.

So it's important to confront the pricing issue in that world of the store.

So it's in Housewares but not Bedding?

Or is it the whole [inaudible]?

Right now, it's in Housewares primarily.

Got it.

Thanks so much.

Our next question is from Margaret Canella with J.P. Morgan.

Go ahead, please.

Good morning, Karen.

In terms of looking at back-to-school sales, are you seeing any trends in spending patterns that might affect your planning for the holiday?

And could you give us an early view on what you think the pros and cons of the upcoming holiday season might be?

You know, I really can't say anything about current trends, but obviously you've just heard our latest thinking on holiday guidance and what we're expecting.

In terms of -- I'm not sure what you mean by the ups and downs for the holiday selling, but we've told you what's been hot, and we would expect that would continue as we go into the fourth quarter.

Okay, thank you.

We have one last question.

It is from Julie Lerner with Metropolitan Capital.

Go ahead, please.

Good morning, Karen.

Hi, Julie.

You had mentioned before that there might be interest in purchasing locations from Lord & Taylor.

I guess going beyond that, is there a general consolidation in the industry that you're seeing, and would it go beyond perhaps in the next coming years to include acquisitions of other large department store chains?

Well, I mean the truth is there's not -- the industry has consolidated quite a bit over the last X number of years, and as you know, our Liberty House acquisition of a couple of years ago was extremely successful, and if there were other properties like that that we could pick up, we'd do it in a minute, particularly at that price.

The problem is there aren't very many of those out there, and the bigger transactions that had been talked about are just far more complicated.

The truth is right now we are completely focused on driving comp store sales and executing those four priorities, and that's far more important to us right now than looking to do acquisitions.

Great.

Thank you.

Ms. Hoguet, there are no other questions.

Great.

Thank you.