梅西百貨 (M) 2005 Q3 法說會逐字稿

Welcome to today's FDS conference call with Ms. Karen Hoguet.

I would like to remind participants that their line will be in a listen-only mode to the Q&A session and also that today's conference call is being recorded.

Good morning.

And welcome to the Federated Department Stores conference call scheduled to discuss our third-quarter earnings.

I am Karen Hoguet, CFO of the Company.

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, www.FDS.com beginning approximately two hours after the call concludes.

Please refer to the investor relations section of our website for discussion and reconciliations of any non-GAAP financial measures discussed this morning.

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 expectations and assumptions mentioned today due to a variety of factors that affect the Company, including the risks classified in the Company's most recently filed form 10-K and form 10-Q.

We were pleased with our performance relative to our guidance in the third quarter.

But if we go back to what we had expected when we started the quarter, we were disappointed that our sales were not stronger.

However, given the sales trend, we were pleased with our overall performance.

Remember the $0.03 of the above guidance performance was due to the Visa settlement, but most of the reason was better-than-expected operating results, particularly in the May division.

And while this is clearly good news for the quarter, we do not believe that there is reason to raise our expectations for the fourth quarter.

The key takeaway is that Federated is on track and achieved slightly better-than-expected profit on lower sales.

And that discipline and ability to react is what is going to be so important as we move forward in the fourth quarter and beyond.

Let's now talk about the components of that performance.

First, let's start with sales.

Sales in the third quarter were $5.8 billion.

This is slightly above what we had expected when we gave guidance on October 6th, with the better-than-expected May performance offsetting the impact on the Federated side of Hurricane Wilma.

Comp store sales in the quarter, which is defined as the Federated comp doors, were up 0.6% excluding the impact of the hurricane.

If we exclude the hurricane impact our sales would have fallen within the 1 to 2% guidance, although below the original plan of 3%.

In the quarter sales were strongest in handbags, fragrances, shoes, dresses and juniors, with the weakest areas of business continuing to be in the Home Store.

Cold weather businesses were also weak due to the warm weather in the quarter, but have picked up since the weather turned colder.

May divisions had stronger sales in October than expected and then their year-to-date trends.

Their sales were slightly above the $2.2 billion high-end of our expected range.

While this trend was driven by incremental markdowns needed to reduce inventories, we are pleased with their October sales trend and hope it continues.

Amongst the old Federated divisions, sales in the quarter were strongest at Bloomingdale's and Florida if we back out the impact of the hurricane and weakest at our central division.

As to the May division's performance, we want to wait a while longer to understand the divisions before commenting on their relative performance.

The gross margin rate in the quarter on a consolidated basis was 40.4% as compared to last year's 39.8%, although last year did include store closing and consolidation costs of $14 million.

So if you exclude those costs from last year, the margin in the quarter last year was 40.2%.

In other words, our margin this year has gone up 20 basis points on an apples-to-apples basis.

And essentially Federated and May's gross margin rates were both about flat with their respective performances last year backing out those onetime costs.

SG&A in the quarter was $2.55 billion or 35.5% of sales.

This is 70 basis points over our rate last year.

Depreciation and amortization in the quarter was $295 million.

The old Federated divisions produced a flat SG&A rate as compared to last year, if you exclude the $10 million Visa settlement this year, and you exclude the $22 million of store closing and consolidation costs from last year.

The sale of the Federated receivables to Citigroup only impacted SG&A as well as operating income, by $5 million as compared to the 10 to $15 million we had expected.

And this is due to the later timing of the transaction than what we had expected when we gave guidance on October 6th.

So if you exclude the impact of the credit transaction, as well as the onetime items I just mentioned, the SG&A rate on the Federated divisions would have been slightly lower this year than last year.

The deterioration in the SG&A rate in total for the consolidated company is due both to the higher base rate at May, compounded by the reverse leverage on the May divisions due to their comp store sales decline in the quarter.

As well as the non-cash fair market value adjustments that were made in the quarter.

Operating income excluding the gain on the sale of receivables and integration related costs was $284 million, up from last year's $175 million or $211 million excluding last year's store closing and consolidation costs.

The pre-tax gain on the credit sale was $480 million as anticipated.

One time integration costs were $63 million, most of which related to asset impairment charges associated with the Macy's stores being closed early next year.

Operating income including the gain and the onetime cost was $701 million.

Interest expense in the quarter was $145 million, which was almost exactly what we had expected.

Tax expense was $123 million, which benefited from the utilization of loss carryforwards on the receivables gain.

If we add back the $85 million benefit from these loss carryforwards, tax expense would have been $208 million or a rate of 37.4%.

This rate was just slightly lower than the expected 37.7%.

Income from continuing operations was $433 million.

With an average share count of 243.5 million shares the diluted EPS from continuing operations was $1.78.

If we exclude the gain and the integration costs diluted EPS in the third quarter from continuing operations was $0.36 a share.

Now on to cash flow.

There were obviously two large transactions in the third quarter impacting cash.

The first was the May closing, which happened on August 30th.

We paid out approximately $5.7 billion in cash to May shareholders.

We funded this with approximately $1.1 billion of cash on hand, and the remainder with $4.6 billion in short-term borrowings under our bridge facility.

We also assumed $5.8 billion of May Co. debt at that time.

And then on October 24th we closed the first part of the transaction with Citigroup for our receivables.

We received $2.8 billion in cash, net of debt paydown, which all went to reduce the short-term borrowings.

Until the rest of the merger-related, short-term debt is eliminated all asset sale proceeds and excess cash will be used to reduce that debt.

However, between the anticipated sale of May credit, the anticipated divestiture of the Bridal group and the divestiture of the announced 82 locations, we anticipate that we will generate more cash than what is needed to eliminate the debt we incurred to fund the merger.

However, we still don't expect that to happen before mid 2006.

In terms of some other items impacting cash, inventory was down versus last year in both Federated and May doors.

And we expect that to be case at year end, as well.

CapEx which only includes the May spending since August 30th was $380 million year-to-date.

We estimate that our annual CapEx for this year, including May from August 30 on will be approximately $900 million, which is well below the budget and anticipated spending for the combined Company this year.

In many cases the spending was delayed until the strategy for stores in overlapping markets was revealed.

As a result of these delays and the resultant carryforward into 2006 of expected 2005 spending, plus the desire to convert all of the May doors by September of 2006 when the names are changed to Macy's, our preliminary capital budget for next year 2006, is roughly $1.6 billion.

In 2007 we are expecting the budget to be lowered to somewhere in the neighborhood of $1.1 or $1.2 billion and potentially lower than that in 2008 and beyond.

So while this is more than we had originally anticipated spending in 2006, the cumulative 2005 to 2008 budget is below what we had anticipated spending when we originally agreed to buy the May Co. last February.

Before I open the call for questions, let's talk for a minute about the fourth quarter.

We are still anticipating comp store sales of 1 to 2% with the May doors expected to add 4.6 to $4.7 billion to our total store volumes.

Five doors will not be open in the fourth quarter due to hurricane damage, three in Florida, two in New Orleans, and will not be included in comp store sales.

Together these five stores produced sales last year in the fourth quarter of $59 million.

Our earnings guidance for the fourth quarter is unchanged at $2.35 to $2.45 on a diluted basis for continuing operations excluding integration costs.

Integration costs in the fourth quarter are still estimated at 100 to $150 million, and including these costs we are expecting diluted EPS from continuing operations to be $2.00 $2.20 in the quarter.

While I know you were all hoping and looking for us to discuss our expectations for 2006, it is still premature.

We are still working on our plans.

The first half of the year will be particularly challenging as the realigned divisions take over.

We will be converting systems and positioning the May doors for the September rebranding to Macy's, which will include the capital spending I just talked about, and also assortment and promotional changes.

It is necessary to make these changes to be able to offer a national Macy's to our customers for the next holiday season.

We are obviously very excited about the opportunities that brings with it.

And as we are making merchandising changes to drive comp store sales, we will also be making changes for our support operations to convert May to our structure and to save the expense that we've always expected to save and improve productivity.

This is all very exciting and all is going well with the integration.

And with that, let me open the call for your questions.

(OPERATOR INSTRUCTIONS) Deborah Weinswig, Citigroup.

Congratulations, Karen, on a great quarter. can you maybe just provide a little bit additional color in terms of the guidance that was provided on October 6, and what you actually delivered in the quarter because obviously you were able to significantly beat -- and maybe even going down in terms of what happened in the May organization?

I think the key thing is that the May sales in October were a lot stronger than we expected.

And that really then translated down to the increase in earnings per share.

And the Federated divisions, in spite of the lower sales, did a little bit better than we had anticipated.

But the big delta was the Visa settlement and the May division performance.

Again, that was relative to what we expected at that time.

And then with regards to the comps were actually delivered at Federated which I think if you took the 50 basis point impact from Wilma and the 60 basis points that was reported at about 1.1% versus the original guidance of 3%, what in your opinion was kind of the key driver between the differential there?

Its hard to say.

I mean part of it clearly had to do with external factors, the aftermath of Katrina, particularly, to a lesser degree Rita and Wilma.

The warm weatheralso affected the cold weather businesses.

We can now see changes in trend, which give us some hope here.

The Home Store was a factor as well.

This time a year ago we were still clearing lots of merchandise in the Home that was not part of the going forward assortments.

And so those were very challenging numbers to year-round on.

Unfortunately that is now just about behind us.

So that gives us some encouragement as we go into the fourth quarter.

So -- it is hard to really point to -- I can't blame it all externally.

But I can't tell you it is all notinternal, as well.

Okay, great.

Thanks for the color.

I appreciate it.

Adrianne Shapira, Goldman Sachs.

Just following up given the fact that you did beat by a significant margin in the third quarter, can you talk about the flexibility going into the fourth quarter given the fact that it is obviously a much larger quarter, and what sort of opportunity there is if in fact sales do not come in at the 1 to 2% range given the larger opportunity?

If you think about the Federated side, A, I start off fairly confident that we will achieve sales in the 1 to 2% range.

There are a lot of good things happening in the business.

And in fact, some of the best trending areas are businesses that tend to do well in the fourth quarter, things like fragrances, handbags, etc.

So I am confident or fairly confident that we will achieve the 1 to 2% in the fourth quarter.

Having said that I think Federated has demonstrated for years our discipline and our ability to react if sales don't materialize.

So I am as confident as I can be from the Federated side we should be just fine.

In terms of May, if October continues, which again I don't have reason to believe, there would be upside in the numbers if the May sales did better.

But again, at this point I don't see any reason that that might happen.

And as I said, we are anticipating taking a lot of markdowns on the May side in order to get the inventories in shape to start fiscal 2006.

And on the May front, you gave the sales expectation but the comps again we should be expecting the negative 5 to 7%?

That's correct.

And on the Federated, given the fact that sales fell short understandable there was a lot of external factors, any thoughts that maybe there is some internal distraction given a lot on your plate that might have caused the Federated sales --.

I was hoping somebody would ask that question today.

We do not believe that is a factor at all.

While there is a lot of work under way on the integration, we had our monthly principal's meeting yesterday and spent half the day on fourth quarter, as we would have in a normal time.

So I think the organization is very focused on delivering sales, and I do not think that is a factor.

Okay, and just the last question clearly fourth quarter is all about getting through the holiday but can you just give us a sense of how you are approaching the integration, perhaps teams and what is the next milestone we should be focused on to gauge how the integration is tracking?

Unfortunately you are really not going to be able to gauge until over a year from now.

We are very busy right now focusing on matching up the May doors to what we are calling sister stores in our current divisions, so that our planners know how to best assort those stores, both in terms of the private brand that we will be introducing to those stores next -- late summer, fall -- really third quarter next year as well as the branded assortments.

So a lot of focus is underway right now in trying to get the assortments right for when we re-brand the stores.

Similarly in terms of the capital spending- getting all the signs converted, all the initiatives underway so that we will be ready to convert next September.

Great.

Best of luck.

Thanks, Karen.

Fillipe Goosensfrom CSFB.

Good morning, Karen, a couple questions here from the fixed-income side.

Any update on the synergy target of $450 (ph) million, do you think you might actually be able to achieve that based on your current read?

Absolutely, but that is in 2007, not 2006. 2006 we still expect to achieve the 175.

Okay.

Then my second question, given that you achieved a little bit more in proceeds from the first phase of the credit card sales, you have the 85 doors that you might sell, there are still David's Bridal, there is still the potential for Lord & Taylor whenever you make a decision.

Given that you will have much more cash flow as a result thereof, any thoughts to perhaps refinancing some of the higher coupons that you inherited from May?

You know, we always look at opportunities to refinance debt from an MPV positive point of view, but if we think about the excess cash once we eliminate the short-term debt associated with buying May Co. we do expect to be back buying back stock.

So there is basically no need -- I mean once you achieve the acquisition, credit metrics, there is no basically no need to pay down --.

Pay down, no, I thought you had said refinance.

No, no, they are two separate questions.

Okay, we are on the same page then.

Thank you so much, Karen.

Wayne Hood, Prudential Securities.

Just coming back to the quarter for the May division a second, you had talked about 70 to $80 million in operating income for that division before the inventory evaluation adjustment.

And I'm wondering how much better were the results in the quarter for that piece of the business?

And also in the fourth quarter you talked about 575 million to 600 million in operating income, and I'm wondering whether or not that has changed.

The truth Wayne, is we are not going to break out May, largely because very quickly we are not going to be able to.

But obviously we exceeded the third quarter from what we had said.

And in terms of the fourth quarter as I said earlier, there is no change in guidance.

Okay, did May in the division, did they see significant gross margin erosion from the promotional activity?

We had said that margins at both Federated and May were relatively flat.

What I don't know is what happened last year in the third quarter.

I don't have that history the way I have it on the Federated side.

So I suspect they took lots of markdowns last third quarter as well.

But again, I don't know that.

It was actually up last year but in any event --.

Yes, I don't know what it was supposed to be.

But there will be lots of markdowns going through.

That leads me to the next question because you talk about 5 to 7% declines in sales in the fourth quarter yet your markdowns are going to be up substantially.

And I'm wondering if your markdowns are up substantially why do you at the same time expect such a significant decline in sales?

Well, you don't when you are clearing out things that aren't selling, you don't necessarily get the sales to the same degree you would obviously if something was selling well.

And my last question, just on the system side, the integration, particularly point-of-sale, because they had a different system than what you are running.

I'm wondering what you're doing to kind of put a band-aid over that and what the resolution of that system would be over time.

It is still being worked on, but again starting in February we will be able to cross shop across the stores from a credit perspective.

And the systems' conversions are being mapped out through really the end of or it is really the second quarter next year.

And then continuing into '07 -- we will skip Christmas and then start again in '07.

But it is all systems people are feeling pretty good about what is in front of them.

All right.

Thank you, Karen.

Christine Augustine of Bear Stearns.

I was wondering about the month of October and relative to your guidance at the beginning of the month, and if in fact there might have been some additional support you received from vendors which would not necessarily be something you would know about or would be able to count on when you gave us the guidance a month ago.

I don't have any knowledge of that, Christine.

Okay, how about your efforts on markdown optimization?

I mean would that have been something that might have been a swing factor?

No.

This is all on the May side.

Okay.

For depreciation and amortization, is the 295, is that just -- that is ex David's Bridal and then two months of May?

That's correct.

So could you just give us kind of a range of what it will be in the fourth quarter?

I will get back to you with that.

I don't have that in front of me right now.

Okay, and on the sale of the May credit card receivables, is there -- what are the decision points that will lead you to the timing of when that will take place?

I think the key thing is we are trying to convert the terms and their portfolio so that it behaves like Federated.

Both Citi and we believe that is a good thing to have happen.

So it is just a matter of how long it takes to do that conversion then?

Correct.

That would dictate when you would sell or?

Yes, to some degree.

Okay, and I guess just finally as you are looking at reassorting May, do you -- is it all internal, or do you have consultants working with you in different markets to try to just make sure you know what the demographics are and sort of what your mix should be for price points and such?

Well, during the summer when we were not allowed to be working with the May people, we had engaged KSA to begin all of that work so that we could hit the ground running.

So they put together lots of demographic, psychographic, every possible data source you can imagine on the May locations as compared to the Federated locations.

At this point now it is all internal, but we are taking all of that data.

And as I said earlier, we are marrying stores to try to sort through the assortment issues.

But all of that data was collected this summer when we weren't talking directly to May because that way it made it possible to start buying the private brands that will come in next fall.

Here's my last question.

It's on David's.

Have you stated what the options will be for monetizing that?

Or can you?

No, we haven't.

I am not sure what the question is.

Just would it be -- would you try to do an outright sale to another buyer, or would you try to do a spin-off?

I'm just kind of wondering if what options you would --.

Strategically we will consider any option that would maximize proceeds.

Okay.

Thank you.

David Glick of Buckingham Research (ph).

Congratulations on the quarter.

Have you finalized which brands that are carried in the May stores that you're discontinuing and if so, have you communicated that to the vendors?

And when might we start to see the liquidation of some of those brands?

You're talking about -- not the private brands -- (multiple speakers) private brands.

That is all still being worked on.

I mean what we are trying to do is have the May stores follow our assortment strategy in terms of differentiation and unique product.

Having said that, we are also trying to keep customers and sales volume.

So in some cases there may be some vendors that we'll introduce into the Federated stores.

In some cases there are vendors that we will eliminate immediately because they don't fit with what we are trying to -- the shopping experience we are trying to give to the customer.

And there will be others that we will downtrend over time and eventually eliminate.

So there's lots of different categories, and that is all still being worked on.

So clearly a high priority right now.

And when do you think you will be in a better position to discuss more of the details of that?

I think it will just unfold over time.

Thank you very much.

Robert Drbul, Lehman Brothers.

On the Federated side, can you just give us an idea in terms of the additional couponing or promotional cadence that you expect to have within that division, how it's going to vary this year from last year?

Additional?

It is going to be less.

Exactly, how much less, I'm sorry.

I don't know how much less, but Federated has been really working to reducing the amount of couponing we do and even within that reduced total number,increase the proportion that is going directly to our proprietary card users.

So that will continue as we go through the fourth quarter.

Right.

Okay, and have you been able to make any changes to the advertising plans in the May business in the fourth quarter?

We haven't tried.

Our thought was let May run their business for the fourth quarter.

Frankly with us staying out of it other than being very strong about wanting to make sure inventories were in the right place at the end of January.

So that is the only place where we've really gotten involved in a major way.

But in terms of advertising, it will go in --actually that's true for the first quarter, as well.

And looking into the fourth quarter on the May side of it, are there any sort of low hanging expenses that you will be able to take out?

In the fourth quarter?

Yes.

No, no.

We've really focused on letting that business operate.

And maximize their results in the fourth quarter.

Okay, and on the inventory side can you give us an idea on the maybe comp store inventories within both businesses?

Well, in both sides the inventories were down sort of in mid single digits.

Okay.

Thank you.

At this time I am showing there are no further questions from the phone lines.

Thank you all very much.

Take care.