Macy’s, Inc. (M)
Q3 2008 Earnings Call Transcript
November 12, 2008 10:30 am ET

Executives

Karen M. Hoguet – Chief Financial Officer

Analysts

Robert Drbul - Barclays Capital
Michelle Clark - Morgan Stanley
Jeffery Stein – Soleil Securities
Lorraine Maikis - Merrill Lynch
Charles Grom - JP Morgan
Deborah Weinswig - Citigroup
Dana Cohen - Banc of America Securities
Adrianne Shapira - Goldman Sachs
Lance Vitanza – Knighthead Capital
Todd Duvick - Banc of America Securities
Uta Werner - Sanford Bernstein
Sam Poser – Sterne Agee & Leach
Matt Wiederrecht – Bond Street Capital
Dana Telsey - Telsey Advisory Group
Michael Exstein - Credit Suisse
David Glick - Buckingham Research Group
Alessandra Rosenfeld - Brean Murray
Lizabeth Dunn - Thomas Weisel Partners
Howard Bryerman – Evergreen Investments
Eric Miller – Barclays Capital
Bernard Sosnick – Gilford Securities

Presentation

Operator

Good morning and welcome to the Macy’s third quarter earnings release conference call. Please be aware that today’s conference is being recorded. I would now like to turn the conference over to your host, Karen Hoguet. Please go ahead, madam.

Karen M. Hoguet

Thank you. Good morning and welcome to the Macy’s Inc. conference call scheduled to discuss our third quarter earnings. I’m 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.macysinc.com, beginning approximately two hours after the call concludes. Please refer to the investor relations section of our website for a 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 specified in the company’s most recently filed Form 10-K and Form 10-Q.

In the third quarter, as a result of the worsening economic climate, we experienced an unexpected weakening of sales trend as compared to the first half of the year. We were pleased, however, that we were able to still outperform our key competitors throughout the quarter, as we have done all year. But we did have to lower our guidance for the fall season on October 10. Our third quarter performance fits within that revised guidance. Sales in the third quarter were $5.493 billion. On a comparable store basis sales were down 6% in the quarter. The slowdown in trend, relative to the first half of the year, was experienced broadly across categories of business and also across geographies. The most significant negative trend change in the quarter happened in the furniture and mattress businesses and at Bloomingdales. However, while the sales trend weakened, Bloomingdale’s still continued to outperform the more upscale competition in the third quarter.

We also saw in the quarter, a resurgence in sales of moderate goods, led by strength in private brands like Karen Scott, Style&Co, American Rag, and Green Dog. The cold weather categories also did relatively well between cold weather accessories, cold weather home textiles, outerwear, and boots. We believe that those areas were boosted both by fashion trends and also due to the fact that they are practical purchases. Our everyday value-priced items also did very well in the third quarter and in the month of October our average unit retail decreased for the first time that I can remember. And another concerning trend in October was a slip in our regular-price business. Earlier in the year the weakness in sales was more in our clearance than regular-price businesses. All of these factors point to the fact that consumers are pulling back in reaction to the economic weakness. This should not surprise any of you.

Geographically, our business was strongest in the Northeast and in Texas during the quarter. New York City was still our strongest market but it did soften some in the second half of the quarter. The weakest geographies continued to be the West Coast and Florida. On a positive note, we did begin to see improved performance in many of the My Macy''s districts, including Chicago, Pittsburgh, and Columbus in the third quarter. Over the past few months, the corporate management team has made formal two-day visits to four of the My Macy''s markets and numerous other unannounced visits to stores involved in the My Macy''s pilot. All I can say is that the passion and energy in those markets has to count for something. It is really still too early to judge the potential lift from the My Macy''s localization strategy. In most families of business we haven’t been able to impact our assortments in a significant way yet, due to lead times and ordering but we are cautiously optimistic that the My Macy''s regional structure will significantly improve our sales trends over time.

Gross margin in the quarter was 39.5%, up 20 basis points versus last year. Remember that last year in the third quarter our gross margin dropped a full point. Needless to say, we are taking more markdowns than we had planned to keep our inventory current. Inventory at the end of October was down approximately 2.5% on a comp store basis. SG&A in the quarter was $2.085 billion, or 38% of sales. This is down $36.0 million, or 1.7%, versus last year. However, due to the sales drop, SG&A as a percent of sales increased 210 basis points. We were able to reduce our expense dollars versus last year in spite of higher expenses for the infrastructure driving our multi-channel strategy through the Internet and lower credit income.

On the positive side, in addition to the savings from the division consolidations completed earlier in the year, we benefited from lower retirement expense, due to reduced headcount from earlier consolidation, the impact of the lower stock price on stock-based compensation expense, and from lower marketing expense in the third quarter. We consciously shifted marketing dollars from Q3 to Q4. Operating income, excluding one-time costs in the quarter, was $84.0 million, or 1.5%. Division consolidation costs in the quarter were $16.0 million for a total of $129.0 million year-to-date. We are still expecting a total of $150.0 million this year in division consolidation costs. Interest expense was $143.0 million and we had a tax benefit of $31.0 million.

The net loss, excluding division consolidation costs, was $0.08 per share with average share count in the quarter 421.3 million shares. Cash flow year-to-date continues to be strong. Net cash provided by continuing operating activities was $317.0 million, up from $285.0 million last year and cash used by investing activities was $606.0 million versus last year’s $618.0 million. And remember, last year the cash from invested activities benefited from proceeds from both the disposition of After Hours and the duplicate May Company locations. Between these two categories of asset disposition we generated $137.0 million less cash this year than last year. Capital spending in the year-to-date was $131.0 million lower than last year.

For the first time this year, we borrowed $120.0 million under our bank credit facility on October 31. We currently have $150.0 million outstanding and expect to need more than this for just a few days over the next month. These borrowings will all be repaid in early December. Now comes the harder part of this call, trying to give you insights into what we are expecting for the fourth quarter and how we are approaching planning 2009. This has to be the most challenging business environment that I have experienced. We do feel very prepared for the next 60 days. Our assortments are looking great and full of great values and newness. Our price points are sharper than ever, our promotions are powerful and marketing strong and our stores and sales associates are providing better service than ever before, based on our consumer surveys. But, we can only control so much. We will have to see how it plays out but we still hope to improve on our third quarter sales trend. And don’t forget the calendar shift this year and last year’s very strong November. As a result, we are expecting the month of November to be down low double-digits, even though we expect the quarter to be down 1% to down 6% and like all holiday seasons that I can remember, it will be a nail-biter.

We won’t be able to predict the season accurately until we’re through it at the end of December. We are expecting continued gross margin pressure in the fourth quarter given the sales environment. And please do also remember that last year our gross margin in the fourth quarter was 70 basis points above a year before, 2006, so we have a tougher comparison this quarter, unlike the third quarter. SG&A in dollars is expected to be above last year in spite of what we accomplished in the third quarter due to higher Internet-related costs, lower credit income, and higher marketing expense. All of this, though, has been factored into the guidance we have given.

We are expecting the fourth quarter earnings per share to be between $1.10 and $1.30 and annual earnings per share to be between $1.30 and $1.50 before division consolidation costs. Having said that, if our sales performance does not improve from the October and third quarter trends, we would be at the lower end of both sales and earnings but as I said, we do remain hopeful that we can do better. But while we are hopeful for the fourth quarter, I have to caution that we are less confident about spring 2009. We will be year-round in weakness but we are increasingly concerned that we won’t see the improvement that we had anticipated as recently as a month ago. Now that doesn’t mean we are expecting further deterioration, but we may not get as much improvement as we had hoped. But until we are through the next 60 days we won’t know how to guide you about 2009. But I will tell you that we are taking a conservative approach and planning those longer lead times items.

For example, as you saw in our release this morning, we have reduced our 2009 capital. We have taken the capital budget from $1.0 billion to approximately $550.0 million to $600.0 million. This compares to approximately $950.0 million expected to be spent in 2008. The reduction was helped by the delay in new stores, which saved us approximately $160.0 million but we are delaying and canceling other projects as well in an effort to conserve cash in this challenging and uncertain environment. We are also reducing our plans relating to merchandise receipts and our expense budgets for both spring and for fall of 2009, given this uncertainty. If trends improve, we will be able to add back some of these capital projects and order more merchandise, but at this point we don’t see any upside in being optimistic. That said, and amid all of the bad news, we do have some things to feel good about and I would like to conclude with those.