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Saks Incorporated (NYSE:SKS)

Q3 2008 Earnings Call

November 18, 2008 10:00 am ET

Executives

Stephen Sadove – CEO

Ronald Frasch – President & CMO

Kevin Wills – EVP & CFO

Julie Bentley – Sr. VP, IR

Analysts

Debra Weinswig - Citigroup

Michelle Clark - Morgan Stanley

Lorraine Maikis - Merrill Lynch

Dana Cohen - Banc of America Securities

Unidentified Analyst

Adrianne Shapira - Goldman Sachs

Michael Exstein - Credit Suisse

Charles Grom – JPMorgan

[Emily Shank] – Barclays Capital

Carla Casella - JPMorgan

Robert Drbul – Barclays Capital

Todd Slater - Lazard Capital Markets

Dana Telsey – Telsey Advisory Group

[Caru Martinson] – Deutsche Bank

Christine Chen – Needham & Company

Operator

Welcome everyone to the Saks Incorporated third quarter earnings call. (Operator Instructions)

I would now like to turn the call over to the Chairman and CEO of Saks Incorporated, Stephen Sadove.

Stephen Sadove

Good morning, this is Stephen Sadove, Chairman and CEO of Saks Incorporated. I'm joined today by Ronald Frasch, President and Chief Merchandising Officer, Kevin Wills, our CFO, and Julie Bentley, our SVP of Investor Relations.

I'd like to thank each of you for taking the time to join us. Today we'll discuss financial results for the third quarter ended November 1, 2008, our outlook for fourth quarter and next year and update you on several other matters. At the end of the call we'll be glad to respond to your questions.

Let me start by asking Kevin to briefly comment on the third quarter results and the balance sheet.

Kevin Wills

Thanks Stephen and good morning everyone. First, let me note that some of the comments on the call today as well as some of the information presented in our earnings release related to future results or expectations are considered forward-looking information within the definition of the federal securities laws.

The forward-looking information is premised on many factors and actual consolidated results might differ materially from projected information if there are any material changes in our assumptions. For a description of the meaningful risks and assumptions related to these projections, please refer to the release and our most recent filings with the SEC, including our most recent Form 10-K.

Saks recorded a net loss of $42.8 million or $0.31 per share for the current year third quarter. The quarter included after-tax items totaling $24.5 million or $0.18 per share primarily related to asset impairment associated with the planned discontinuation of the Club Libby Lu operations and the write-off and adjustment of certain deferred tax assets primarily associated with the federal and net operating loss tax credits that are subject to expiration at the end of fiscal 2008.

For the prior year third quarter we recorded net income of $21.6 million or $0.14 per share which included $4.3 million or $0.03 per share of certain after-tax items. For the quarter the company’s operating loss excluding certain items totaled $18 million this year compared to operating income of $51.3 million last year.

Our consolidated inventories at quarter-end totaled $1.02 billion up approximately 4% on the total basis and approximately 4.4% on a comparable stores basis. In the luxury business inventory purchase lead times typically are six to nine months. When we originally planned fall 2008 we expected low single-digit comparable store sales growth and obviously actual results are far below our initial expectations.

The rapid deterioration in the retail environment has caused a gap between sales trends and inventory levels to widen. We are diligently working to align our inventory levels but we are obviously not there yet as evidenced by the gap at quarter-end between the comparable store sales decrease of 11.5% and the comparable store inventory increase of 4.4%.

As Stephen and Ronald will discuss shortly we are working with our vendor partners to better align inventories but this is not a quick fix. We currently anticipate that it could take several more quarters to properly align inventories based on the current level of consumer demand.

At quarter-end we had approximately $20 million of cash on hand and approximately $81 million of direct outstanding borrowings on our $500 million revolving credit facility. Funded debt including capitalized leases and borrowings on the revolving credit facility totaled $649 million and debt to capitalization was 37.2% without giving effect to cash on hand.

Let me take just a few moments to provide everyone with some additional information about our capital position. Our $500 million revolving credit facility will terminate in September, 2011. As previously noted we had $81 million outstanding on the facility at the end of third quarter. Subsequent to quarter-end on November 15, $84.1 million of senior notes matured and as anticipated we retired the notes by drawing down on the revolving credit facility.

We have traditionally utilized the revolved credit facility only to fund seasonal working capital needs but given the current status of credit markets we elected to utilize the facility to retire the maturing senior note as opposed to refinancing.

We may look perspectively to refinance the $84.1 million portion which is now in a revolving credit facility but any such financing would be dependent in part on credit market conditions. The revolving credit facility has no covenants unless the availability falls below $60 million.

At that time the company will be subject to a fixed charge coverage ratio of at least one to one. As of today the company has $192.3 million of senior unsecured notes and a 2% $230 million convertible debenture.

The next debt maturity is $45.9 million of senior notes in December, 2010 followed by $141.6 million of senior notes maturing the following year in October of 2011.

The $230 million convertible debenture matures in 2024. I would also like to comment briefly on the company’s pension plan as I know there have been a number of questions recently regarding the status of company’s plans and the impact of the current financial markets may have on future expense and funding requirements.

The company maintains the defined benefit pension plan. However this plan was curtailed in 2006 which froze the benefit accrual for all participants except those who had attained age 55 and completed 10 years of service.

The majority of the plan participants did not meet the age and years of service criteria, therefore the annual increase associated with service cost is relatively modest. As we began 2008 the plan was slightly overfunded. However consistent with the performance of the financial markets as a whole the plan has experienced a significant decline in asset value during 2008.

We will not know the impact on the 2009 expense for funding requirements until some time of January of 2009. However barring an unforeseen dramatic rebound in the financial markets over the next month and a half, we expect a significant increase in annual pension expense in 2009.

Our current estimate will be an increase in the range of $12 million to $14 million. And we may have to make a cash contribution to the plan in order to maintain an 80% funding level. We would currently estimate the 2009 funding requirement to be in the $5 million to $15 million range.

Stephen Sadove

Thanks Kevin, our sales results and operating performance in the third quarter were well below our initial expectations reflecting the rapidly deteriorating macroeconomic conditions throughout the period.

Our comp store sales declined 5.9$, 10.9%, and 16.6% in August, September, and October respectively culminating in an 11.5% decline for the quarter.

This compares to the 11.4% comp store sales gain reported for last year’s third quarter. During the quarter we experienced progressive and pervasive softening across all geographies, merchandise categories, and channels of distribution.

In previous quarters comp store sales performance of the New York City flagship store which comprises approximately 20% of our total company revenues, meaningfully outperformed the balance of the store base.

We saw this trend change in the third quarter with the New York store sales performance only slightly better then the company average. October was a more difficult month for this location as the financial markets worsened, news of bank failures and additional layoffs took hold, and tourism slowed.

Certain of our newly renovated stores outside of New York City however continued to post better then the chain-wide average results. For the quarter the number of transactions and average dollars per transaction declined from last year’s third quarter.

Also its important to note that during the quarter we experienced a greater decline among our high end customers consistent with the performance of the financial markets. This is in contrast to the stronger trends among this group that we had seen earlier in the year.

From a category perspective we saw wide spread weakness in women’s apparel and softness in areas such as women’s shoes and handbags, that had delivered explosive growth during 2007. Some of the relatively better performing merchandise categories for Saks Fifth Avenue during the quarter included cosmetics, fragrances, jewelry, men’s contemporary sportswear, and men’s shoes.

While Saks direct was a relative bright spot posting a comp store sales gain of approximately 10% for the quarter on top of last year’s nearly 40% third quarter growth, sales growth in this business slowed significantly from prior quarters.

We recently added the ability to ship merchandise to Canada from our site which should increase future sales opportunities. Although all Fifth’s comparable sales performance was better then the company’s average for the period, trends in this business were also below prior quarters.

In spite of the extremely challenging environment our organization is continuing to respond appropriately. As Kevin noted the gap between sales and inventory trends widened in the third quarter due to the rapid deterioration in consumer demand. We’re working aggressively and collaboratively with our vendor partners to return merchandising cancelled orders where possible to better balance inventories.

Additionally we have added and will continue to add targeted promotional activities to stimulate sales and reduce inventories. Our gross margin rate decreased 640 basis points in the quarter. Approximately 450 basis points of the year-over-year deterioration in the rate was due to an increase in markdowns, an increase in the percentage of business generated during promotional days as consumers continue to shift purchases to promotional events, and in the inability to leverage a relatively fixed level of permanent markdowns during the quarter against the 11.5% comp store sales decrease, while I’ll explain more in a minute.

The balance of the rate deterioration related to the acceleration of certain permanent markdowns in one select area from the fourth quarter last year to the third quarter of this year which we estimate negatively impacted the third quarter by approximately $0.05 per share and modest deleverage on buying and distribution costs.

Unlike the traditional department store business model, the luxury channel has traditionally concentrated a higher percentage of permanent markdowns in the second and fourth fiscal quarters. Saks Fifth Avenue has followed this approach for many years and 2008 is no exception.

Based on the company’s historical permanent markdown cadence the majority of permanent markdowns are taken in the second and fourth quarters and can vary significantly between periods based on the level of content of inventory.

This is in contrast with the permanent markdowns taken in the first and third quarter which are relatively fixed. Given the relative fixed expense associated with the third quarter permanent markdowns and the third quarter comp store sales decrease of 11.5%, we experienced gross margin rate erosion as we were unable to leverage the expense associated with the permanent markdowns.

The company’s third quarter permanent markdown cadence was consistent with the third quarter of last year with the exception of the limited acceleration of permanent markdowns that I had mentioned.

We managed our SG&A expenses during the quarter well reducing expenses by approximately $17.5 million or 8.7% from the prior year excluding certain items. While we were unable to achieve expense leverage on our weak sales performance reflects variable expenses and reduced certain fixed expenses as well.

Earlier this month we announced our plans to discontinue the operations of our Club Libby Lu specialty store business by the end of the first fiscal quarter in 2009. Club Libby Lu was a much better strategic fit with our traditional department store business and discontinuing its operations will allow us to focus 100% of our time and resources on executing the strategies of our core Saks Fifth Avenue business.

This business was not profitable and its discontinuation should add modestly to the company’s EBIT performance going forward. We have completed nearly all of our 2008 strategic capital improvements which will total approximately $125 million.

As you know our store capital strategy is focused on investments in highly productive stores and categories. This year we have opened or remodeled over 100 vendor shops and completed several other store projects including the renovation and expansion of our Naples and Boston stores and the renovations of the Los Angeles South Coast Plaza, Bal Harbor, Miami, and Houston flagship stores.

We introduced our highly successful 1022 Shoe concept in five other key markets; Beverly Hills, Houston, Phoenix South Coast Plaza, and San Francisco. In our New York City store we completed the extensive renovation of our first floor handbag area featuring among other things a CHANEL Boutique that is double the previous space as well as the Ferragamo, Tod, Fendi, and Bottega Boutiques.

The renovated Gucci handbag boutique will be ready next week. New CHANEL, Guerlain, SK-II, and Dior cosmetic areas were unveiled. Perhaps the most exciting flagship renovation is the complete renovation of our third floor women’s designer area which is underway.

The first phase of this renovation, the long-awaited addition of CHANEL apparel was completed this fall. The third floor project in its entirety will showcase over 35 designers and will be finished in 2009. In addition our expanded and renovated women’s Fifth Avenue Club will be complete in January.

We opened three new Off Fifth stores within the last month or so; Deer Park, Long Island, St. Augustine, Florida, and Mercedes, Texas, all patterned after our prototype store which opened in Orlando this spring.

Even in this difficult environment we’ve been pleased with the early results at each of these stores. We’ve announced plans to add four additional stores and one replacement store in 2009.

Let me ask Ronald to make a few additional comments about our merchandising strategies and inventories.

Ronald Frasch

Thanks Stephen, and good morning. I’d like to take a moment to give you some thoughts on how we’re approaching the near and mid term buying cycles. As Kevin indicated in his remarks the lead times in the luxury retail space are quite long.

As an example, we’re now planning our buys for the fall 2009 season. This is product that will ship to our stores between May and October of 2009. The first step in helping our buyers and planners establish their purchase plans for fall 2009 was to communicate appropriate guidance on the outlook for the business.

We expect the challenging macroeconomic environment to continue in the near-term, which will continue to effect customer demand. Based on this we have outlined specific direction for our merchant team as they approach development of both assortment and purchase plans for next fall.

We can no longer utilize a this-year, last-year approach. Our mind set both on the investment side and the product attribute side needs to have a this-year, next-year approach. This simply means that we can no longer rely mainly on historical information, product or financial, to guide our decisions.

High-end consumers have reduced their level of consumption while at the same time, they are taking a more discernable view of the product offering. So with this in mind we challenged our merchants to approach the business and their buys from zero base, both financially and strategically.

First we have to justify our matrix, both on points of distribution as well as the level of investment that we make. Then we have to make sure that we only invest and focus on business categories that yield strategic and financial value to the business.

Those categories that do not fit through this filter will be eliminated. Then we must make the hard decisions on a brand-by-brand basis. Those brands that are nice to haves can’t exist in a new environment. Each brand must lend both financial and strategic value to the company.

I’ve also challenged them on product attributes. Product needs a new definition of purpose. So much of the financial approach we have to look forward and not back as it relates to product attributes. While Saks has always been a fashion-forward company, the core essence of what our customers wanted was the same year-over-year with modest evolution added to the design.

That has changed. The core sensibility of what the customer is looking for in a fashion product is very different from what they were asking for last year. The next two points involve our work with the vendor community.

We set out a few years ago to strengthen our vendor relationships and have been very successful in our efforts. These new or strengthened relationships are paying dividends right now as many of our vendors while certainly not solving our problem have stepped up and are helping to mitigate the pressure we are facing.

What I’ve asked our merchants to do is to continue working with the vendor community to ensure we are getting the necessary support which ranges from merchandise returns to order cancellations to marketing and staffing contributions.

The next challenge is our procurement cycle, we need to work closely with our vendor partners on the timing of the procurement cycle. In other words reducing the risk and the process by tightening the long lead times.

We also need to better manage with our brands the content of each delivery window. We can’t do this alone. Its paramount that our vendor partners continue their efforts towards supporting Saks in managing through this difficult time and beyond.

Before I hand it back to Stephen, I’d like to say that even though the current environment is the most challenging that I have ever experienced, I remain optimistic for the future of Saks Fifth Avenue. I believe some of our more recent strategic initiatives, such as our commitment to a good, better, best assortment, through the nine box grid approach, the reorganization of our merchandise planning and buying functions, the addition of our point-of-sale [client tally] systems, and the implementation of various in-store and support process improvements, will allow us to manage through this very difficult environment.

Stephen Sadove

As we enter the holiday season our stores look great, our marketing and promotions are compelling, and our service has never been better. We’re doing everything in our control to stimulate sales and to control inventories, expenses, and capital spending.

Having said that the current macroeconomic and retail environment is unprecedented and consequently its impossible to predict the fourth quarter and beyond with any degree of certainty. Assuming a continuation of October sales trends into the fourth quarter, which again we can’t know if this is too high or too low, we outlined several assumptions for the fourth quarter and fiscal year 2008 in today’s release.

Obviously a material change in the sales trend up or down will change these assumptions. Comp store sales inventory levels are expected to be up in the low single-digit range at fiscal year end. Assuming a continuation of consumers’ propensity to purchase promotional merchandise rather then full price product and based on our fourth quarter promotional calendar and permanent markdown cadence, the result will be a more significant year-over-year decline in gross margin rates in the fourth quarter then we experienced in the third quarter.

Of course the degree of the deterioration largely depends on sales performance. For the fourth quarter absolute SG&A dollars excluding certain items are expected to be down modestly from the prior year as we continue to reduce payroll, travel, insurance, and incentive compensation expenses among others.

As we look to next year, we remain very concerned about the environment and are planning accordingly. In 2009, it will certainly test our ability to operate in a very difficult environment. We continue to focus on what we control. We have inventory receipts down approximately 15% in the spring and are being even more conservative as we look towards fall.

We will continue to add targeted promotions and take other actions in order to more appropriately position our inventory levels. If we continue to experience difficult sales trend and as we strive to balance inventories, gross margins will continue to be under pressure.

We’re taking further actions to reduce our SG&A expense structure to coincide with the lower revenue base. We’re able to reduce SG&A expenses in the third and fourth quarters and expect to do so as we go into next year.

We have identified additional cost reduction opportunities and are optimistic that savings will be realized from this effort in 2009 and beyond. The organization is very focused on expense reduction and cost containment as we are seeking ways to decrease our aggregate expense base and/or offset those expenses that are subject to inflationary pressures.

In light of the challenging environment we will reduce our capital spend by about 40% in 2009. Although our plans have not yet been finalized, we expect to spend about $75 million which will allow us to carry out our maintenance capital, make incremental systems and direct infrastructure enhancements, add the new Off Fifth locations, and execute select Saks Fifth Avenue store projects, including the completion of our New York City third floor renovations.

Some renovations that were on the tentative drawing board will prudently be postponed until the environment improves.

Our customers react to the volatility and weakness in the financial markets. When the markets stabilize and begin to improve, we believe our customers will return to their more robust shopping patterns. We have an exceptional brand, valuable real estate, a loyal customer base, solid vendor relationships, and an outstanding team.

Although we are staying the course with our long-term strategies we are certainly making short-term adjustments as needed in this environment. We are positioning the company to be an even stronger organization when the economy improves.

At this time we will be pleased to entertain questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Debra Weinswig - Citigroup

Debra Weinswig - Citigroup

Can you talk a little bit more in depth about your work with Alex Partners and how should we think about the improvements that we’ve seen with regards to SG&A performance in the third and fourth quarter of this year, what we expect to see in the fourth quarter and how much momentum do you have going into 2009?

Stephen Sadove

I feel real good about the work that we’re doing, not only with Alex, Alex is working with us on a part of the cost base, primarily in the purchasing arena. But we’re looking at every line item within the P&L so its having to do within the stores. How many people do we need to have within the stores to support the sales base.

Obviously at a lower sales base you don’t need the same number of people that we’ve had before. We’re looking at the organizational structure within the headquarters operations and looking at what do we need to support the base.

We’re looking at whether its travel expenses to any number of the purchasing items and we think that there is a substantial number in terms of savings that we can see in 2009. The 2008 results in terms of lower SG&A in the third and fourth quarters, part of it is driven by the commission base but part of its also driven by real savings that we’re seeing in terms of expense reductions.

I don’t want to give specific numbers as it relates to 2009 in terms of what the year-on-year trend will be. There clearly are some inflationary costs that are pushing you on the other side of it, but I would expect that we’re going to see some reductions as we go into 2009.

Debra Weinswig - Citigroup

I think there’s a credit card promotion that you’re running right now along with HSBC, can you go into some detail on that and who’s liability etc. with regards to that promotion?

Stephen Sadove

Yes, the program we’re calling it a major purchase account promotion where with a minimum $2,000 purchase in a single day across the store an individual can get no interest, no payments for a year on their purchases. We’ve seen a very good response on the part of the consumer to it. We had done it in the jewelry category a year ago, saw a good response, and we are doing it across the board.

HSBC is funding this. Its not a liability on our part and we feel very good about the partnership, its part of the partnership that we have with HSBC and I think its something that’s going to help us during this holiday season.

Operator

Your next question comes from the line of Michelle Clark - Morgan Stanley

Michelle Clark - Morgan Stanley

I was hoping you can provide us with some color on November sales trends month to date and then if you look at a [D score] metric among the major department stores, you score lowest next to Macy’s. It looks like if we assume sales trends continue at this level we could see negative EBITDA next year. Just wondering thoughts on how you’ll pay down debt coming due next year or are assets sales a possibility.

Stephen Sadove

We can’t really comment mid-quarter on mid-quarter or mid-month on November sales. We saw the sales through October.

Kevin Wills

As it relates to 2009 we’re not in a position now to give any guidance on that. We will be finalizing our plans as we move through the fourth quarter and we’ll be speaking to you and others about that in fourth quarter earnings release call. So we’re not going to comment on EBITDA.

But I would comment that we are very focused on 2009 as we’ve indicated. We’re taking actions to bring our inventory levels more in line. We have expense initiatives on board so we understand from a financial perspective what we’re trying to do.

Stephen Sadove

I’d echo what Kevin’s saying and tell you that this is an all hands on exercise relative to understanding that we are in a different environment. You’re going to see the cash reductions in capital as an example of the actions and obviously the expense actions that we’re taking as well.

Kevin Wills

As it relates to 2009 debt maturity, as we outlined earlier today, we do not have anything maturing in 2009.

Operator

Your next question comes from the line of Lorraine Maikis - Merrill Lynch

Lorraine Maikis - Merrill Lynch

Just wanted to follow-up on the reduction in capital spending for next year, is that all renovation spending that you’re pulling out and what do you think the impact will be on those stores slated for renovation?

Stephen Sadove

We’re in fact continuing, if you look at our $75 million, and again this is not finalized, what you’re seeing is we’re going to continue to do vendor shops, we’re continuing the completion of our New York store. We have some IT infrastructure investments that we’re continuing to make but you’re not going to be seeing as rapid, there are a number of store renovation projects that we’d like to do over time but you’re not going to be seeing in the near-term.

We’ve had some very good discussions with our vendor partners relative to whether its either new distribution or renovations to shop that we’d like to see over time. They are cutting back on their capital as well and its really a partnership in terms of what needs to be done in near-term and we’re in a mode that we want to make sure that we do get a positive EBITDA performance and that we’ve got to manage our expenses and some things which I’d like us to be doing we’re just going to have to go on the back burner for right now until the economy gets better.

Operator

Your next question comes from the line of Dana Cohen - Banc of America Securities

Dana Cohen - Banc of America Securities

I will confess you lost me on the gross margins, so can you just go over the pieces of the 600 basis points?

Kevin Wills

If you look at the gross margin, we were down about 640 basis points in the quarter. As we indicated about 450 of that was due to just incremental markdowns as well as a shift of consumers making more of their purchase on promotional days versus regular days, meaning more sales concentrated into events like Friends and Family.

And then the balance was due to the inability to leverage the permanent markdowns. As we had indicated previously our permanent markdowns are generally concentrated in the second and fourth quarter consistent with the luxury channel generally markdown cadence.

Having said that we do incur markdowns as well in the first and the third quarter and they are a smaller number and relatively fixed based on the vendors that go within that cycle so we had the markdown expense from the markdown expense in the quarter and that was against a comp sales decrease of 11.5% so you saw some erosion there.

And then we also had some modest deleverage on the buying and distribution cost again consistent with those costs being relatively fixed against 11.5% comp sales decrease.

Dana Cohen - Banc of America Securities

So just going back, 190 is deleveraging, no matter where or what it delevered, but it is deleveraging on fixed costs.

Kevin Wills

Yes, 450 and 190, yes.

Dana Cohen - Banc of America Securities

Where was the shift of these Q4 markdowns into Q3?

Kevin Wills

That’s part of the 190.

Dana Cohen - Banc of America Securities

Why isn’t that in the 450?

Kevin Wills

Because those were permanent markdowns that we took in the fourth quarter [conditionally] we accelerated into the third quarter.

Dana Cohen - Banc of America Securities

I guess what I’m not understanding is why is that a deleveraging issue and not just a markdown issue.

Kevin Wills

Well it can be a combination, but if you think about it this way, if we took those permanent markdowns on the last day of the quarter we did not have the ability to drive the sales against those to leverage that expense.

Dana Cohen - Banc of America Securities

So you took the $0.05 as markdowns taken at the end of the quarter—

Kevin Wills

Yes, we shifted about $0.05 worth of permanent markdowns in select categories that we traditionally take in the early fourth quarter into the very end of the third quarter.

Dana Cohen - Banc of America Securities

On the SG&A side, how much of the dollar reduction year-over-year is from commission which would be just the natural change in the sales pattern and how much of it is you took costs out?

Kevin Wills

We have not broken out the components of that, but there is in the neighborhood of probably $5 million plus variable expenses that we [flexed] down and the balance is just taking out costs throughout the company.

Dana Cohen - Banc of America Securities

So if $15 million or so is reduced costs, should we be thinking that that is going to accelerate going forward?

Kevin Wills

We have not given specifics on what the fourth quarter would look like if that’s where you’re driving at—

Dana Cohen - Banc of America Securities

I’m not trying to get it for the fourth quarter, I’m just trying to say you probably took your first shot at SG&A reduction in a more aggressive manner in the third quarter, would it be reasonable to think that as we move into Q4 and into next year that that number should get greater because logically you’d be funding more not fewer things.

Kevin Wills

Generally speaking yes, but again there can be different costs that occur in each quarter, things like marketing costs may vary quarter over quarter so you may see different changes but we are very focused on expenses, we’re taking some expense out of the business and as we move through 2009 we’re optimistic that we’ll identify additional opportunities.

Stephen Sadove

I think it’s a good indication of what’s the behavior that’s going on. There are going to be things in 2009, Kevin talked about the potential of the pension increase costs and things that we’re going to be dealing with but its clear that we’re taking and going to continue to take very aggressive actions to flex our cost base.

Dana Cohen - Banc of America Securities

If you took down $80 million on the revolver for the debt payment, it’d be fair to think that you will continue to have that at the end of the fourth quarter given the numbers you’re looking at, correct?

Kevin Wills

That’s our assumption, yes.

Operator

Your next question comes from the line of Unidentified Analyst

Unidentified Analyst

Could you talk a bit about working capital and how that may be impacted in this coming year as dealing with sometimes smaller vendors who are facing tighter credit conditions, are you going to have to be extending working capital to them?

Kevin Wills

As we look out to the next year as we’re thinking about taking our inventory purchases down, our inventory levels down, we would expect to see a modest benefit from working capital. I do not anticipate any vendor terms causing us any pressure there.

Operator

Your next question comes from the line of Adrianne Shapira - Goldman Sachs

Adrianne Shapira - Goldman Sachs

If you could talk about the interplay between the full line and Off Fifth, you talked about comp inventories ending up 4.4%, just talk about where the inventory [shook out] between the two divisions, perhaps talk about margin pressures between the two and in terms of slowing some of these markdowns through Off Fifth in an effort to preserve the brand at the full line stores.

Stephen Sadove

We don’t break out the financial, we don’t do segment reporting on Off Fifth. The trend in Off Fifth has been a bit better then the trend in the full line businesses for some time now although I said that the Off Fifth trend is not as good as it was previously, we don’t breakout the gross margin of one of the businesses versus another.

I think that the issue on the inventory and the comp inventory assumption that was put into the press release is really predicated based upon a certain top line sales number, if the top line sales number is different then the inventory would be different. We’re going to be clearing inventory as fast as we possibly can and whether or not we’re going to do it in the most efficient way that we can, so some of it is going to get cleared in full line, some of it is better served to be cleared in Off Fifth and frankly we’re even testing clearing some of it in our direct business.

We’re going to look at moving it down. But what the Off Fifth business is traditionally about a quarter of the product that they sell is the clearance product from full lines so we’re going to continue to, in the best manner get some of those brands and the excess product into Off Fifth as quickly as we can.

Adrianne Shapira - Goldman Sachs

Should we expect that percentage to move higher?

Stephen Sadove

I don’t think you’re going to see a dramatic shift in the percentage. It might go up a little bit but I don’t think that its going to be a dramatic change in the amount that the Off Fifth is taking. I’d frankly rather clear it out as fast as we can during the next couple of months.

Adrianne Shapira - Goldman Sachs

It sounds like in the fourth quarter you’re bracing for potential continuation of these kind of comp trends and then gross margins hit worse in the fourth quarter and in light of that it still sounds like perhaps comp inventory levels to end up positive at the end of the fourth quarter, should we expect then to still have this excess inventory heading into the first half that could impact margins in the first half of 2009?

Stephen Sadove

I think it totally depends on how much inventory we’re able to clear over the next three months. If we end up, let’s assume that we were to end up with a low mid single-digit comp increase of inventories going into 2009, then its going to put some pressure on the gross margin in the beginning of the year.

That’s why Kevin said that its going to take us a bit of time to get out of it if in fact these mid-teen declines in sales continue and the issue that we’re wrestling with and I’ll just use it now as an opportunity to talk about it, is given the six to nine month lead time in terms of purchases, when we made the purchase decisions coming into this fall, our full line business was growing let’s call it into the mid to high single-digit growth in the fourth quarter of last year.

We made an assumption that we were going to be performing at a low single-digit top line growth even when we gave guidance for the fall season, we said that we thought we would be flat to positive, slightly low single-digit positive that that would get us, based upon the purchases that we made that we would come out of this season with flat to negative comp inventory performance.

I don’t think any of us anticipated that the high-end consumer was going to fall off as dramatically as they have to the fact that the comment that I made that in the most recent period, it’s the higher end consumer that has stopped their purchases even more.

I don’t know whether or not that’s going to continue in the same manner as they start to see some of the discounts and the promotions that are going to be occurring over the next couple of months. So to the extent that, and that’s why we’re being very cautious as we buy for next year and I said that we’re going to be buying in the minus 15 and perhaps even lower range as we are out there buying for fall of next season I think in terms of receipts.

So how much inventory we have going into the spring is really going to be determined by how much we’re able to clear over the next couple of months. If we don’t clear it all, then we’re going to have a gross margin issue as we go into the first part of the year.

I do believe that because we’re cutting the receipts as they relate to spring so you’re seeing spring receipts coming down dramatically as well that one way or another we will be out of this as we get out of the spring season but I think the question of how much it impacts spring is going to be totally related to how well we do with clearing the inventory over the next couple of months.

Adrianne Shapira - Goldman Sachs

And then just a question, it sounds like you’re going through a rigorous assessment of brands and categories that are relevant, if you can share with us perhaps directionally what that means for assortments, where we could be seeing changes perhaps when you think about that good, better, best positioning what that would look like as we come out of this.

Ronald Frasch

The primary thing we’re going to do is maintain the good, better, best model in all of our stores. That’s critical. But within that model what we’re doing is we’re assessing each brand and its viability by market. So there will be brands that will not be viable in all probability and they will be eliminated and there will be distribution by market that may not have the potential to be either financially successful or strategically appropriate and we will be taking the appropriate actions on those.

We’re going through a very, very thorough detailed review. We are in the process obviously at the beginning stages of our fall 2009 purchases and we are not passing any paper until we have an agreement among ourselves on how we’re going to proceed by brand.

Stephen Sadove

I think its very interesting what Ronald’s doing with the team and is using as an opportunity to zero base business as opposed to just what did you do last year, what are you going to do this year. You heard it a little bit in this remarks, this is a zero base thinking.

We know that we believe very strongly in who we are, the good, better, best within luxury and its an opportunity for us to take a very hard look at every brand, the assortment by store and take actions while we’re in this environment.

Operator

Your next question comes from the line of Michael Exstein - Credit Suisse

Michael Exstein - Credit Suisse

One thing you haven’t talked about is the store base, and clearly as business gets more difficult how are you thinking about numbers of stores, renegotiating some of the occupancy expense, what do you thinking about what the organization looks like two or three years out as you grind through this tough time.

Stephen Sadove

First of all I don’t see dramatic changes in the store base right now. We undertook this process called parallel planning a couple of years ago that had to do with the assortments in every store and essentially a long-range plan of growth for every store.

And we felt very good about the track that we were on in terms of the improvements. There are a few stores, especially as we’ve gone into this environment over the last six months or so, that aren’t performing where we want them to perform.

We have to look and what we’re doing is going through the exercise of understanding every store and whether it makes sense and what are the opportunities if there are opportunities to modify the terms or to close the store here and there. We did close our Ft. Lauderdale store so we’re certainly not adverse to closing stores.

Some of them we have covenants on that we’re just not going to be able to get out of. We’re in discussions constantly with our developer partners and we’ll see whether or not there are going to be any that make sense to close over time. We’re not hesitant to do it if economically it makes any sense to do so.

Michael Exstein - Credit Suisse

I guess the real question is as things get more and more difficult when do you think the real estate interest realized in enforcing covenants may put a much larger situation into question.

Stephen Sadove

I think again, we look at each one of them when you say, I’m not sure I understand when you say larger situation—

Michael Exstein - Credit Suisse

If you have some handful of stores, whether its five or 10 that are not four-wall profitable or cash flow positive, sitting on those stores costs the corporation a lot of money and means the money that you have to invest in those stores that you don’t get from those stores are being deprived for the rest of the organization keeping it healthy and vibrant.

Stephen Sadove

Absolutely, I think that’s the discussion on the handful and we’re not talking a lot of stores but on the handful of stores, that’s exactly the discussion that we have with the developer community and see whether we can get them to work with us relative to if we can close this store do we put the resources into either a new store somewhere or some other store within the base and that’s exactly the discussion that we have with them.

Michael Exstein - Credit Suisse

Do you think you’re making any progress?

Stephen Sadove

I think we are making some progress, yes.

Operator

Your next question comes from the line of Charles Grom – JPMorgan

Charles Grom – JPMorgan

Its likely that you’re going to end the year with about $300 million available on the revolver and could finish the year about six to 10 times levered, I know that you don’t have any covenants and you had that in the press release but does this level worry you at all and as you look into 2009 do you think you can continue to pull on the revolver, have you talked to the banks, do you think you’ll hit some sort of level where a red flag is going to be raised?

Kevin Wills

We’ve not given any specific direction or guidance relative to where we’re going to end at the end of the year on the revolver other then I do expect to have an outstanding balance on our revolver due in part to the draw down to pay down the $84 million senior note that matured yesterday.

Presently we believe that we have ample capital resources inside of our structure, inside of our revolver. However as always, this could certainly change depending on future performance of the company but we believe that we have a good relationship with our current bank group and so we understand where we’re at relative to that facility.

Charles Grom – JPMorgan

I can get very easily to negative EBITDA for next year, just wondering if you could give us a bit of guidance for interest expense and working capital needs.

Kevin Wills

I’m not providing 2009 guidance at this time. We will provide that at the end of the fourth quarter.

Operator

Your next question comes from the line of [Emily Shank] – Barclays Capital

[Emily Shank] – Barclays Capital

Could you just give me the breakout of what portion of your 2009 estimate or forecast for CapEx is maintenance?

Stephen Sadove

We don’t have it broken down for 2009 yet in that level of detail, I would tell you that its probably, if I were estimating at this point and it might somewhere in the neighborhood of 30 to 40, in that range for maintenance CapEx.

[Emily Shank] – Barclays Capital

In terms of the new stores that you have coming on line, the four Off Fifth that you mentioned, are there any other stores that you’re locked into and leases over the next couple of years for new ones?

Stephen Sadove

No, none.

[Emily Shank] – Barclays Capital

And then what percent of your store footprint is four-wall EBITDA negative?

Stephen Sadove

We don’t break it out by store or percentage of stores that are four wall EBITDA negative.

[Emily Shank] – Barclays Capital

I’m not completely following how if you were baking in low single-digit comp increases on the top line for the third quarter you wound up with plus 4.4% comp inventory, is that because you didn’t sell through all the inventory that you had planned to in the second quarter so you had some carryover, or what’s the right way to think about that.

Kevin Wills

In the quarter we were down about 11.5% comp, contrast that with the initial expectation to be up low single-digits, so call that 2% to 3% comp. That’s probably in the neighborhood of $120 million difference in the top line versus our original expectation.

So you take that and the inventory that would have been reduced associated with that sale then you get a much different comp inventory increase had sales materialized in our original expectation.

Stephen Sadove

Had what Kevin said come about, you basically would have been flat to down on your comp inventory and you would have been growing at a low single-digit so you would have had the two would have certainly been in line.

[Emily Shank] – Barclays Capital

How are you defining comp store inventory.

Kevin Wills

Its inventory this year versus last year on the comparable store base this year versus last year.

Stephen Sadove

We don’t change the number of stores that dramatically.

Kevin Wills

We’ve got a couple of new Off Fifth doors and you don’t have the Ft. Lauderdale store that you had last year otherwise the comp base is essentially the same year-over-year.

Operator

Your next question comes from the line of Carla Casella - JPMorgan

Carla Casella - JPMorgan

Did you say how many letters of credit you had outstanding at the end of the quarter?

Kevin Wills

Letters of credit outstanding were in the $25 million range.

Carla Casella - JPMorgan

Can you talk about last year in the fourth quarter any adjustments that you made for vendor rebates or allowances that you may or may not have this quarter, I’m assuming that would be part of the pressure on gross margin.

Kevin Wills

We don’t break out as a level of vendor support year-over-year. As Ronald and Stephen noted however we continue to believe we have very favorable partnerships with our vendors. They’re working with us on things ranging from cancelling receipts to returns as well as at the end of the season we expect to get our vendor support no different then we have in prior years.

Carla Casella - JPMorgan

And then you mentioned you expect working capital to be positive, was that for the fourth quarter or for the full year 2008?

Kevin Wills

No the comment earlier was maybe looking forward to 2009 and working capital needs and my comment was as we pull back on the inventory purchases next year you may see some positive benefit on working capital in 2009.

Carla Casella - JPMorgan

What about in 2008, do you think you could see positive for the year? It looks like to me like its going to be negative for the year, is that fair? Do you expect to be a negative in full year 2008 or do you think you can recoup the uses you’ve made through the first nine months and be positive in 2008?

Kevin Wills

I’m not giving any specifics on that but you can look at where inventory levels are and where we’re projecting at the end of the year.

Operator

Your next question comes from the line of Robert Drbul – Barclays Capital

Robert Drbul – Barclays Capital

When you consider in the last few months and your expectations into the holiday season from where we are today, in terms of the competitive environment how intense has it been and how intense do you expect it to be over the next 45 days or so when you consider your gross margin assumptions?

Stephen Sadove

I think its going to be very competitive during the rest of the holiday season. Some of our competitors have broken sale. I think that, as we talked about wanting to clear as much of this inventory during the fourth quarter as we can, and we have more inventory then I’d like us to be sitting on right now, I think that you’re going to have to be more competitive to get the consumer to shop so I would expect us to see a highly competitive and highly promotional period.

Operator

Your next question comes from the line of Todd Slater - Lazard Capital Markets

Todd Slater - Lazard Capital Markets

On Q4, I understand that the gross margin deterioration is based on sales performance but you guided to a more significant year-over-year decline in gross margin rate for the fourth quarter versus the third quarter, but does that include the acceleration of markdowns into Q3 from Q4 because I would think that that would be a little bit of a benefit to Q4 or am I missing something.

Kevin Wills

For that one instance, it would be a little bit of a benefit for Q4 however we factored that one benefit into the guidance that we gave.

Stephen Sadove

Again, that’s predicated on the sales decline that we saw in October if that were to continue.

Operator

Your next question comes from the line of Dana Telsey – Telsey Advisory Group

Dana Telsey – Telsey Advisory Group

Can you talk a bit about where does private label merchandise, it was something that I think you were working on I think earlier, fit into the mix and the go forward plans, how you’re looking at your marketing budget and the spend, what’s being adjusted both in terms of dollars and just in terms of what items, is it email advertising, is it print, how are you adjusting and also what was your own credit card penetration this quarter and how do the trends look going forward?

Stephen Sadove

Credit card penetration has been in the 45% range for Saks. It hasn’t materially shifted over the course of the year. If we look at our marketing budget and I think that you’re seeing a fair amount of our marketing expense, there are two ways that you look at the marketing expense.

There’s our own spending, there’s the co-op support and vendor support that we get. Much of our own spend at this point is what I would call promotional sale advertising during the quarter and you’re continuing to see a gravitation towards as we clear out the product, more of that in the near-term spending against whether it’s the discount event, the EGC event, the major purchase account event so you’re continuing to see more of the dollars in the near-term going against that.

I do think that over time as we look at 2009 there are going to be some implications in terms of how marketing dollars get spent. The consumer is clearly shifting his and her head set and need to better understand why these products are worth what they’re worth and you’re going to probably see an evolution in terms of some of the marketing spend.

I think all of the print magazines are under pressure in this environment so its going to be a tough road relative to the total marketing dollar spend. Our marketing dollars because so much of it is co-op is not an enormous portion of our total budget but I do think you’re going to see some evolution in terms of how the dollars get spent as we go into 2009.

Ronald Frasch

Our objective with private brand has evolved over the past couple of years and actually we are feeling very positive about some of the initiatives that we have under way for example, this fall we re-launched real clothes, of course we call it clothes real because we had to change it.

Considering everything its off to a good start. And our objective with private brand is to really focus on those areas that we’re not able to either have developed for us through branded product or take advantage of commodity opportunities and recently within the past two weeks we announced the hiring of consultant to prioritize our men’s business, a gentleman who I’ve worked with in the past, who’s really a very talented men’s merchant who will be working with us to pull our entire men’s private brand portfolio together and really enhance the Saks Fifth Avenue label.

Stephen Sadove

Over time I think it represents a very good growth opportunity. There’s a separate from just the own label private brand, there’s also the growth of brands where its either exclusive to us or very limited distribution. An example of that would be the line [Soka] that we just launched recently but I think that there are a number of brands like that.

Operator

Your next question comes from the line of [Caru Martinson] – Deutsche Bank

[Caru Martinson] – Deutsche Bank

Just to follow-up on the competition question, on the high end in particular, do you feel that you’re giving up any share here or is it really just that the consumer has completely closed their wallets.

Stephen Sadove

I clearly don’t think we’re giving up share. If you look at our relative comps to our closest in competitor, Neiman’s if you want to look at that, we’ve been holding up and faring well, I feel horrible about the comps in general, but if I look at the relative performance to Neiman’s if I look at it on a month of October, we were down 16.6, Neiman’s was down 20.7. On a quarter to date we’re down 11.5, they were down 14.5.

So we’re certainly not losing share on that but I don’t think anybody is doing well in this environment and I think it’s a highly competitive environment. If I look at Nordstrom, they’re having a tough go of it so the consumer, this is a consumer issue, if you were to do a correlation between the Dow Jones performance and our performance, it’s almost a 0.9 something our square in terms of the trend.

I was talking a year or two ago to all of you about the single best predictor and this was when the Dow was at 12 or 13, the best predictor of our performance is tell me where the Dow is at and I’ll tell you how we’re doing and I said at that time if we got down to 9 or 9500 I’d be very concerned and now we’re down at a level well below that.

Clearly our consumer doesn’t feel wealthy. They’ve seen a major hit on their portfolios and they aren’t in the mood to shop and that’s having an effect on us right now and its not so much a share gain versus our direct competitors, its that the consumer is in a frozen mode, shell shocked relative to how they feel about their portfolio.

[Caru Martinson] – Deutsche Bank

I know its tough to breakout the tourism aspect for the New York market but have you seen a shift in the quarter from the tourism as the dollar has strengthened?

Stephen Sadove

I don’t have the specific numbers. Last year we said that about, and again I’m going to talk as a percentage, if New York outperformed the remainder of the store base that about 25% of their incremental growth was being driven by the incremental tourism in the store.

My guess is you’ve seen several hundred basis points probably of the deterioration of the New York performance is being driven by a slowdown in the tourism. I think that the slowdown in New York though and remember its gone from way outperforming to performing closer in line with the rest of the store base, part of it is due to the tourism, but a much bigger portion of it is due to what’s going on in New York relative to the consumer, the financial market and how people, we’re in a, basically New York is the epicenter of a lot of the issues that are being faced in the financial markets.

Operator

Your next question comes from the line of Christine Chen – Needham & Company

Christine Chen – Needham & Company

I was just wondering, I know overall women’s has been weak but have you seen a difference in performance between contemporary versus the more traditional bridge lines and curious how premium denim is performing.

Ronald Frasch

The contemporary and again these are all relative basis, the contemporary in men’s has been a strong performer for us and women’s it has performed, let me say less worse then the ready to wear component that would be the Sang.

Premium denim is very interesting. What is not selling are the basics, we’re selling any of the new fashion, the skinny leg, and its really dramatically changed from having the basis business because the basic business has just really deteriorated.

Christine Chen – Needham & Company

Looking forward into spring, would you continue to make bets on fashion premium denim then versus the basics?

Ronald Frasch

Absolutely as we are with contemporary. Contemporary really is, we’re trying to as quickly as we can continue to evolve to a much more trend driven, reaction driven product offer.

Operator

Your final question is a follow-up from the line of Dana Cohen - Banc of America Securities

Dana Cohen - Banc of America Securities

On the gross margin if my math is right the $0.05 from the markdown shift from Q4 to Q3 is about $12 million pre-tax or 170 basis points, so I was just wondering going back to the deleverage issue, is the deleveraging really only 20 basis points?

Kevin Wills

In a year, your aggregate cost estimate there is correct. The deleveraging is probably closer to 150 basis points plus on that sales drop.

Dana Cohen - Banc of America Securities

So the chunks are maybe slightly different then you talked about, it can’t be 190 basis points of fixed inclusive of the $0.05.

Kevin Wills

The 190 basis points was the markdown shift as well as the buying distribution deleverage.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Stephen Sadove

Thank you very much everybody and we’ll talk to you at the end of the fourth quarter.

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Source: Saks Incorporated Q3 2008 (Qtr End 11/01/08) Earnings Call Transcript
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