Jones Apparel Group, Inc. Q3 2008 (Qtr End 10/04/08) Earnings Call Transcript

Executives

Wesley Card – President & CEO

John McClain - CFO

Analysts

Todd Slater – Lazard Capital Markets

Robert Drbul – Barclay’s Capital

Jennifer Black - Jennifer Black & Associates

David Glick – Buckingham Research

Ben Rowbotham – Goldman Sachs

Tom Truxillo - Banc of America

Evren Kopelman – JP Morgan

Virginia Chambliss – JP Morgan

[Kevin Buller] – Morgan Stanley

Jones Apparel Group, Inc. (JNY) Q3 2008 Earnings Call October 29, 2008 8:30 AM ET

Operator

Welcome to the Jones Apparel Group 2008 third quarter earnings conference call. (Operator Instructions) On this conference call the company will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 about its businesses. These statements are based on current expectations of future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

For a detailed discussion of these risks and uncertainties and other important factors that could cause actual results to differ materially from the company’s expectations, the company directs your attention to its Annual Report on Form 10-K for the fiscal year ended December 31, 2007 including but not limited to the statement regarding forward-looking disclosure and item 1A Risk Factors therein and to its other filings with the Securities and Exchange Commission. The company does not undertake to publically update or revise its forward-looking statements as a result of new information, future events or otherwise.

Before we begin the company would like to point out that once again this quarter supplemental slides are available on the company’s website for download. I will now like to turn the call over to Wesley Card, President, and CEO; please go ahead sir.

Wesley Card

Good morning everybody, welcome to this morning’s conference call to discuss our third quarter results and outlook for the balance of the year.

Earlier this morning we reported results that were consistent with our announcement several weeks ago with adjusted earnings per share coming in at $0.34.

Needless to say the economic climate remains extremely difficult with a very uncertain near-term trend. Earlier this year we saw the need for conservative and disciplined execution, however since the decline in the economy has been rapid and much worse then anticipated, we revised our expectations accordingly.

As you are aware September retail sales were down. In fact it was the worst decline registered in three years which reignited the dramatic sell-off on Wall Street several weeks ago.

Comparable store sales reported by our customers for September reflected this trend with department store comps down by 11.8%. October comps look like they’ll follow a similar trend in September.

Virtually all of our major department store customers reported declining comps and reduced their sales and earnings guidance after the September sales results were announced.

Our own chain of domestic stores registered a similar decline with comps down 8.3% in September and ending up at minus 2.4% for the quarter. As you also know US consumer confidence dropped to a record low falling to 38 which was reported just yesterday.

And finally the employment trends and concerns about long-term recession continue to weaken the overall outlook. On the positive side, oil prices continue to decline significantly. The dollar is appreciated particularly against the euro and we’re seeing general softening in raw material prices and costs.

These trends with the raw material prices coupled with new textile export supports that have been announced in China will help to hold down costs especially with the effect of reduced worldwide demand.

What we’re seeing is more then ever consumers are in a buy now wear now mode. Women’s sportswear has been the most challenged business while tailored basics, dresses, suits, and footwear are showing more resilience in the current climate.

In consideration of these trends we provided for additional markdown support in our third quarter results as well as in the guidance for the balance of this year. We also adjusted our expectations for our own vertical retail operations downward and anticipated higher promotions to keep inventories in line with demand.

We continue to actively manage our balance sheet, we ended the quarter with a significant cash balance of $200 million, a significant decline in inventories, and no short-term borrowings outstanding.

While we’re in a very tough time, I believe the turnaround strategies we put in place last year combined with our product initiatives have helped stabilize and strengthen us to better manage during these volatile times.

Later in the call I’m going to go into more specifics on our various businesses and at this point I’m going to turn the call over to John McClain to review our results and outlook in more detail.

John McClain

Thank you Wesley, and good morning everyone. We reported results for the third quarter of 2008 on a GAAP basis of net income of $27 million and earnings per share of $0.33 as compared with a net income of $400 million and earnings per share of $3.97 last year, and the prior year results include $258 million after-tax gain related to the sale of Barney’s which closed in early September, 2007.

Throughout the remainder of my discussion all amounts related to adjusted results from continuing operations unless otherwise noted. Adjusted results exclude the impact of the repositioning of our l.e.i. business to Wal-Mart, of exiting the Moderate Sportswear business and other unique items not considered part of our ongoing operations which aggregated $3 million in the third quarter of 2008.

The adjusted items in the third quarter of 2007 included the impacts of the aforementioned actions and also included the reversal of the tax reserve all of which aggregated $78 million. Adjusted results from continuing operations also excludes the results of Barney’s for all periods.

As you are all well aware the challenging retail environment continued throughout the third quarter for department and specialty stores and for our own chain of retail stores. The retail sector is facing high-energy prices, slowing economy, rising unemployment and a credit crisis.

In response retailers have been tightening their inventory buys and relying on promotional efforts to move goods. Our results for the quarter have also been impacted by these factors. For third quarter total company net revenues were $965 million, compared with $1.045 billion in the prior year.

The revenue decline was primarily the impact of exiting the Moderate Sportswear line. Excluding that impact which is approximately $65 million, revenues declined 1.5%. Total company operating income was $55 million versus $89 million last year.

Current year operating margin was 5.7% and included over $4 million of charges related to the bankruptcy filings of our two customers. Excluding those charges operating margin for the quarter was 6.1% versus 8.5% last year.

The reduction in operating margin reflects the highly promotional retail environment for the quarter including our own stores. Adjusted EPS from continuing operations was $0.34 for the third quarter compared with $0.51 in the prior year.

Before I discuss the segment results and our updated guidance for 2008, I’ll highlight some balance sheet and cash flow items. Accounts receivable were $475 million at the end of the third quarter versus $506 million in the prior year, a decrease of 6%.

Accounts receivable turn on an annualized basis was 7.2x for the quarter which is consistent with last quarter and compares with 7.4x last year. The portfolio remains very healthy from an aging perspective.

Inventory was $548 million at the end of the quarter versus $590 million in the prior year, $42 million decrease or 7%. The most significant decrease was in our jeanswear group due to the exiting of the Moderate Sportswear lines.

As we mentioned before we remain focused on maintaining clean inventories and at quarter end the quality of our inventories was much improved from the prior year. On an annualized basis inventory turn for the quarter improved slightly to 4.9x compared with 4.8x last year.

During the nine-month period we generated $8 million of cash from continuing operations which is a $120 million improvement over the prior year’s period where we used $112 million of cash. This improvement was primarily due to lower inventory balances, the receipt of a tax refund, the absence of final payment related to transition service agreement with Polo Jeans Company in 2007, partially offset by lower earnings.

There were no share repurchases during the quarter. Total debt was $783 million which is flat with the prior year. Our revolver remains undrawn and we ended the quarter was approximately $200 million of cash.

We forecast to have approximately $300 million of cash at year-end and we remain financially strong. At its meeting yesterday the Board of Directors approved the quarterly dividend of $0.14 per share. Now I’d like to discuss the third quarter 2008 results for each of our segments and update our segment guidance for 2008.

This information is included in the slides we posted to our website today.

For the quarter wholesale better apparel revenues were $351 million compared with $367 million last year. In sportswear revenues for Jones New York Signature increased versus last year and was offset by decreases at Nine West, Jones Collection, and Jones Sport.

In suits and dresses revenue performance met our expectations with continued increases in both Evan-Picone suits and dresses. Segment operating profit margin was 10.4% this year and includes $1.5 million of charges related to the bankruptcy filings I mentioned. Excluding those bankruptcy charges operating profit was 10.8% compared with 12.5% last year reflecting the highly promotional and overall challenging state of the women’s apparel market.

Wholesale jeanswear revenues were $204 million compared with $266 million last year reflecting the impact of exiting the certain Moderate Sportswear lines which were about $65 million lower this year then last. Increases in revenue of our l.e.i. brand were offset by lower revenues in Gloria Vanderbilt, largely due to the impact of the customer bankruptcies I mentioned and decreases in other brands.

Segment operating profit margin was 6.1% this year and includes $1.8 million of the charges related to the bankruptcy filings and excluding those charges operating profit margin was 7% compared with 6.8% last year. This improvement is primarily due to the absence of the lower margin Moderate Sportswear lines.

In wholesale footwear and accessories revenues were $297 million this year versus $293 million last year; a 1% increase. The increase was due to increased sales of our footwear to international licensees and increased sales in handbags exceeding a reduction in domestic wholesale footwear and jewelry sales.

Segment operating profit margin was 10.3% this year and includes $900,000 of charges related to the bankruptcy filings. Excluding those bankruptcy charges operating profit margin was 10.6% compared with 14.1% last year reflecting the highly promotional environment in the wholesale footwear channel, the impact of inventory liquidations as we continue to keep our inventory very clean, the increase in our international component of our business which comes at a lower profit margin, the impact of rising costs, and the timing of certain benefit related costs.

In retail revenues were $173 million compared with $177 million last year. Total same store sales of footwear increased 2.4% while same store sales in apparel decreased 10.9% resulting in an overall 2.5% decline.

As we progressed throughout the quarter the economic news worsened and consumer confidence continued to drop which negatively impacted our sales. Additionally third quarter is impacted by the move out of warm weather goods and into cold weather goods and the buy now wear now mode of the consumer is delaying purchases until they are required.

As a result September was a very challenging month and the same store sales declined almost 6% in footwear and almost 13% in apparel for combined decrease of 8.3%.

Segment operating margin was negative 11.5% versus negative 8.2% last year. We lost $6 million more in this segment this year then last, gross margin dollars were down on slightly lower sales while gross profit margins were increased slightly.

Operating margins were also impacted by the write-off of certain software costs of about $1.5 million this quarter and the loss of leverage as comparable store sales decreased.

A positive note, our mall based footwear stores and our online businesses generated improved results quarter over quarter.

On total year guidance we continue to see unprecedented activity in the marketplace whether its in single day increases and decreases in the stock market, dramatic swings in the price of oil and gasoline or the number of announced layoffs, all of this continues to play on the psyche of the consumer who has become extremely cautious and has reduced their level of spending.

We kept this in mind as we recently update our guidance and little has changed in the overall environment. We continue to be cautious as we maintain the 2008 guidance that we provided a few weeks ago at a range of $0.93 to $0.98 per share.

In summary, our guidance is total company net revenue ranging from $3.62 billion to $3.67 billion and total company operating margin ranging from 4.4% to 4.8%. On a segment basis, wholesale better apparel the forecasted revenue ranges increases slightly to $1.23 billion to $1.25 billion and operating margins range from 9.8% to 10.2%.

For wholesale jeanswear the forecasted revenue range decreases slightly to $800 million to $815 million reflecting a small shift of orders from 4Q 2008 into 2009 and an operating margin range of 5.8% to 6.2% reflecting the continued challenging market conditions in the junior zone.

For wholesale footwear and accessories the forecast revenue range decreases slightly to $1.035 billion to $1.05 billion and a slightly reduced operating margin range of 7.3% to 7.7% reflecting the current trends in the market.

For retail the forecasted revenue range decreases to $720 million to $735 million reflecting lower projected comparable store sales for the fourth quarter where we project comp sales to be negative 7% and operating margins ranging from negative 6% to negative 7.6%.

A few more details to assist in modeling, we expect interest expense of approximately $41 million, equity and earnings of joint ventures of approximately $0.5 million, an effective tax rate of approximately 35.3%, weighted average shares outstanding for the full year of approximately 84 million, operating cash flow of $130 million to $145 million.

We’ve carefully reviewed our capital spending plans for the remainder of the year and have lowered our estimate for expenditures to approximately $73 million, this from our previous estimate of $80 million to $90 million.

What’s included in the $73 million is approximately $35 million for technology, $10 million for new retail store outlets, $15 million for remodels of existing retail stores, with the remainder spent for distribution center, showrooms, and offices.

Lastly depreciation and amortization of approximately $95 million.

That concludes my comments and I’ll turn the call back over to Wesley.

Wesley Card

Thanks John, I’ll now walk through the core drivers of our performance this quarter and talk about our various business segments.

As I noted earlier although market conditions are tough, we remain committed to our strategy and are moving forward with our turnaround activities which lay the foundation for future success. We continue to push new concepts and marketing efforts albeit at a more conservative pace given the environment.

Let me first address the performance in our vertical retail operations which include 980 store locations in the United States. The footwear and accessories comps were strong during July and August but dropped by 5.7% in September ending in a plus 2.4% comp for the quarter.

For the full quarter the footwear outlet store comps or the value segment were up slightly however mall traffic was light and the full price mall door comps were down. We believe the transition to fall shoes and boots in September impacted sales as consumers waited for cooler weather and promotional pricing.

We still believe that based on the early trends this should be a very strong boot season although given the difficult climate it may become highly promotional.

Our apparel outlet store comps were down 10.9% for the quarter and the trend becoming more negative as we moved along into September. As John noted gross margins for our retail segment were comparable to last year overall as we again promoted heavily to move stock.

The SG&A percentage was up as we lost the comp store sales. Although sales are seasonally higher in the fourth quarter we anticipate a similar margin trend as we remain focused on moving our inventory and believe the customer will be shopping for bargains.

Even in this challenging environment we continue to focus on our core brands and initiatives to drive performance. During the quarter we reopened several key renovated doors including the flagship Nine West store on Fifth Avenue in New York City, which has shown excellent results since reopening.

Our launch of a new multi brand footwear concept, ShoeWoo, took place as scheduled in early October in Menlo Park Mall in New Jersey. Results are very encouraging to date, we’ve been open about four weeks, and we’re planning on two more test doors before rolling the concept out further.

Several photos of the store are included in the slide presentation provided with the call and I really invite you to look at those because it’s a very interesting and modern store design that we have in place with this concept.

Moving forward we’re going to be very selective in new store openings, focusing on value in our outlet stores and with very careful evaluation of full price mall locations. With lease costs softening the economics in some locations may improve over the next year.

Turning now to wholesale apparel, women’s apparel in general remains challenging with the consumer so stressed she is turning more then ever to wear now and higher value items. While we remain in a casual trend, there is some evidence of basic tailored items as selling.

Our Jones New York Collection replenishment business which consists of basic separates is selling very well. Jones New York Signature our dressed up casual brand, continues to be strong. Its outperforming competitor offerings and due to intensification by our major customer our sales are increasing.

Suits and dresses are selling better at retail. We believe this is also reflective of the value and ease of wear they provide and even over the past month we have been making planned sales in these categories.

Collection fashion sportswear category is not as strong, however there is newness and color on the floor now with more focused item intensification which we had planned in the stores for holiday. For example there is an excellent presentation of cashmere items now in the stores in a variety of styles and colors in the Jones New York Collection area.

Turning to Nine West Sportswear, its doing somewhat better at retail although a much lower plans in inventories. The product is improved and our customers are supportive of this line, yet we’re still not satisfied with the direction of the label so during the quarter we shifted the creative direction of all Nine West products under [Fred Allard]. Fred has revitalized the Nine West footwear and accessories products as you know, and his responsibilities will now include sportswear and jeans.

Fred’s creative talent has had an immediate impact and we believe our offerings for next fall will be much stronger.

Anne Klein Bridge sportswear has been substantially improved for 2009. We’re very positive about the newly designed product and customers are pleased with its direction although as you would expect its very difficult to rollout new doors in the current retail climate, particularly in Bridge which is struggling and is located primarily in the luxury department stores.

But we’re very patient with this brand, we think the designs are on track and we will be successful over time.

We continue to broaden the AK Anne Klein line and we included a pure casual active wear component for spring 2009. Here again we continue to improve the merchandise assortments and although sales growth is difficult at this time, we’re continuing our strong marketing support for the brand.

Let me now turn to wholesale footwear and accessories the retail selling performance in this segment has been stronger then apparel consistently throughout the year and the past month has shown relatively strong sales, generally close to or above planned however promotional levels in the department stores have been high.

As I mentioned earlier we expect this to be an excellent boot season based on early trends and dress pumps are also showing early strength.

Our handbag penetration continues to increase and retail performance has been much better. Costume jewelry overall has still been a relatively weak category at retail and consistent with other categories become more promotional.

Our Nine West international business continues to growth in strong double-digits and as you know we made a small investment in our Asian partner GRI last quarter, working very closely with them now to maximize what we believe to be an excellent long-term growth opportunity in China and Asia in general.

Turning to jeanswear from a retail sales perspective our base brands Gloria Vanderbilt and Extensions performed generally in line with channel which was also challenged. As you know back to school sales were relatively weak which has been widely reported.

Also reflective of this our Energy Junior tops business which sells in that channel was challenged in the quarter and we also noted that knit tops lost favor to a more woven trend for the junior customer.

We’re addressing this challenged with the addition of some woven items and moving to more fashion in our knit tops which we believe had trended to basic.

Nine West denim continues to gain traction and we are more closely integrating this with our sportswear and as I mentioned it is now under Fred Allard’s creative direction.

Our private label rollouts with Macy’s of Style&co. and Charter Club commenced shipping in July. Overall it performed very well since the original launch and we think this can be a substantial volume opportunity for us as we move into next year.

Finally l.e.i. brand as you know got off to a very exciting start with Wal-Mart. We are now again growing sales in this brand. Since the launch in June we have shipped over 10 million units to Wal-Mart. They are really very pleased with our execution and the results thus far.

Selling to date has been very good given the overall retail climate and the back to school comments that I made earlier and the 1,200 hotspots have now been set up in the stores. We’re also very pleased that we’re going to retain those hotspots for the spring 2009 season which is a very positive trend for us.

Related category launches for l.e.i. are now in place. The footwear business is going to be done by Steve Madden which commences shipment this quarter. We have an order in our costume jewelry division for spring 2009 and in the first quarter of 2009 we launch under licenses with selected partners in handbags, intimate apparel, sleepwear, and sunglasses.

We continue to look at other growth initiatives to diversify our distribution channels. The internet strategy continues to develop and solidify although still a relatively modest piece of our overall sales base.

Improvements to the sites, marketing programs, and systems generated an 85% increase in third quarter internet sales which accelerated throughout the quarter. Year-to-date internet sales have increased by 43% over last year and are now up to $19.1 million year-to-date.

We launched Jones New York apparel online in early September and Anne Klein is still on schedule to launch in early 2009.

We expect to reach just over $30 million in revenues this year which would be an increase of 44% although the back half is accelerated at a much more rapid pace as these improvements have taken hold.

So in summary we’re obviously looking at a very uncertain retail climate and difficult economic conditions. Accordingly retail customers are planning spring 2009 order cautiously. Yet in the face of this we remain intensely focused on our strategy of continuous improvements to our merchandise and products building on our very strong customer relationships and an unwavering focus on outstanding execution for our partners.

We’re also very focused and committed to the return of profitability of our vertical retail operations and have laid much of the foundation to achieve that goal.

We are however making appropriate near-term adaptations to deal with the economic forces outside of our control. They included very measured inventory planning for 2009, a substantial slowing of capital expenditures and new store openings in 2009, careful examination of our expense structure to reduce expenses, maintaining close contact with our retail customers and a very cautious approach to new projects.

We believe with these actions and the commitment of our outstanding and very experienced management team, we’ll weather these conditions and emerge as a stronger, leaner company when the economy improves.

We’ll now open it up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Todd Slater – Lazard Capital Markets

Todd Slater – Lazard Capital Markets

I was wondering if you could talk a bit about what your direction is going to be across the enterprise for inventory commitments next year relative to 2009, up or down on a dollar basis. Could you give us a sense of your expense direction as well as is there an opportunity to lower the dollar level year-over-year just given the environment that we’re in. What would be the reasonable expectations on a thumbnail type level and also could you be a bit more specific about your sourcing costs. What percent up or down change are you anticipating as you’re starting to plan your orders at this point?

Wesley Card

In terms of inventory I think that we haven’t forecasted yet for 2009 or provided guidance obviously, we do that on our year-end call. We will expect retailers will order conservatively. Thus far with the spring bookings that we had in September we were booking on track. We are cognizant of the fact that if economic conditions change obviously there could be some adjustment in those orders but at this point orders are pretty much on track, even in fourth quarter we’ve shipped in October very well against orders. We’re seeing very little in the way of cancellations.

I think the overall conservative pattern that was expected for the back half has been helpful. We’re planning very cautiously against, we have realistic plans for next year. We planned realistically for spring. We bought our inventory against that. I would say that even with the drop that we showed in inventory this quarter, our inventories are actually much more current then they were last year.

Keep in mind that we have an inventory build up that we’re funding for, the big Wal-Mart program. I think as we end the year, inventories will be in excellent shape and more current because we’ve been very focused on moving quickly on our excesses, keeping inventory clean as we go through the year.

I think if there’s any inventory increment next year, its going to be to fund new programs such as l.e.i. Its hard to give specific numbers but we would think in our businesses inventories will be directionally down with the exception of l.e.i. where we’re building inventories and the focus is keeping them very clean.

In terms of costing, we’re seeing flatten out. We’ve been able to hold costs just by pushing back very hard. There’s been weakening demand as you know globally. We’re seeing cotton and other raw material prices start to drop. Wool prices are coming down. Gasoline prices, that affects energy use by the factories, so I think prices are going to steady out.

It’s a very, in this climate even where we’ve had some cost pressures, and its been more difficult in footwear its just very difficult to raise prices. The consumer is going to be focused more and more on value and we’re getting pretty stiff price resistance. I think generally pricing is going to hold into next year and we should see costs steady out as well based on this recent trend of very softening global demand.

Todd Slater – Lazard Capital Markets

On l.e.i., you’re operating the sportswear piece of the business yourself and then licensing out all the other categories?

Wesley Card

Correct, well yes, we’re doing jeanswear in-house, we’re doing knit tops, the junior tops in-house, and we’re doing costume jewelry in-house. Thus far we’ve licensed out the footwear, handbags, underwear, all the other areas that I mentioned, mostly to people that are highly equipped to deal with Wal-Mart, for example Steve Madden has a very large business with them to begin with. They’re much more able to service that real value footwear area and I think in that case they bring a lot of junior design talent to the product.

I think they’re going to be able to execute a really good product and deliver the product on schedule. Where we don’t have the in-house expertise, we’ve been actually going outside and licensing.

Todd Slater – Lazard Capital Markets

On your $0.93 to $0.98 guidance for the year, can you give us a more specific sense into what comps you’re assuming in the fourth quarter, what markdown allowances you’re reserving relative to last year, are there significant increases there, is there a conservative type of guidance?

John McClain

I did say in my comments when we looked at comp store sales in the fourth quarter and we’re projecting a slightly over 7% decline compared to last year. Now last year was also a very challenged quarter in the retail sales.

Todd Slater – Lazard Capital Markets

And markdown allowances are similar trend that you’ve been seeing?

Wesley Card

Yes, I think we took a more conservative approach there particularly as we came out of September, we looked at what the trend was in third quarter, took a more conservative approach toward fourth quarter and think we’re covered for these conditions.

One of the things about fourth quarter there is a natural gift giving period that kicks in here in holiday sales so hopefully that will help in moving inventory and taking out goods. I think the consensus now is for probably holiday sales to be down, flat to down a couple of percent but that still is a very big business and hopefully we’ll continue to clear goods through the channel.

And retailers did order conservatively for fourth quarter, if you remember, we’ve been saying that consistently so that should help as well.

Operator

Your next question comes from the line of Robert Drbul – Barclay’s Capital

Robert Drbul – Barclay’s Capital

Given the environment how should we think about the management of cash levels versus debt levels and more specifically how do you plan to address the $250 million in notes due next year?

John McClain

As you’re seeing it in the quarter we got over $200 million in cash now, we’re projecting to have over $300 million at the end of the year. We’re in a strong financial position now and its based upon a disciplined and conservative approach we’ve taken. Next year we’re going to generate some more cash so we’ve got some financial flexibility. The financial markets have seized up a bit but we think they’ll open again and we’ll monitor our opportunities in the market as they come about.

Robert Drbul – Barclay’s Capital

Concerning the covenants in your revolver and also in your notes, given where the current levels of operations for the business is today and where you see it going forward how restrictive are those covenants to current levels?

John McClain

We met the covenants for the quarter and we anticipate at our guidance that we’ll meet the covenants at year-end. It’s a very volatile environment and we’re looking and working towards 2009 and working towards our guidance but until we get through that process we’re going to continue our approach and work hard and protect cash.

Operator

Your next question comes from the line of Jennifer Black - Jennifer Black & Associates