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Saks Incorporated (NYSE:SKS)

Q2 2009 Earnings Call

August 18, 2009 10:00 am ET

Executives

Stephen I. Sadove – Chairman and Chief Executive Officer

Ronald Frasch – President and Chief Merchandising Officer

Kevin Wills – Chief Financial Officer

Julia A. Bentley – Senior Vice President of Investor Relations

Analysts

Deborah Weinswig - Citigroup

Christine Chen - Needham & Company, LLC

Ben Rowbotham for Adrianne Shapira - Goldman Sachs

Charles Grom - J.P. Morgan

[Rob Davis] – [Unidentified Firm]

Michelle Clark – [Unidentified Firm]

Lorraine Hutchinson – [Unidentified Firm]

Robert Drbul – [Unidentified Firm]

[Karoo Martinson – Unidentified Firm]

Todd Slater – [Unidentified Firm]

[Jason Trahio] for Emily Shanks – [Unidentified Firm]

Dana Telsey – [Unidentified Firm]

Paul [Nury – Unidentified Firm]

[Jeff Kobelars – Unidentified Firm]

[Michael Shredguess – Unidentified Firm]

Operator

Good morning. My name is [Adrianne] and I will be your conference operator today. At this time I would like to welcome everyone to the second quarter call for Saks, Incorporated. (Operator Instructions) Thank you.

I would now like to turn the call over our host, Mr. Steve Sadove, Chairman and CEO of Saks. Sir you may begin.

Stephen I. Sadove

Thank you. Good morning. This is Steve Sadove, Chairman and CEO of Saks, Incorporated. I’m joined on the call by Ron Frasch, President and Chief Merchandising Officer, Kevin Wills, our CFO and Julia Bentley, our Senior VP of IR. I’d like to thank each of you for taking the time to join us.

Today we’ll discuss financial results for the second quarter and six months ended August 1, 2009, our outlook for the balance of the year and update you on several other matters. At the end of the call we’ll be glad to respond to your questions.

Before I turn the call over to Kevin to discuss the financial results, let me take a couple of minutes to give you my overall assessment of what we’ve accomplished since the economic downturn began. First let me note that some of the comments on the call today as well as some of the information presented in our 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 or in the various risks related to our industry and our company. For a description of the risks and assumptions related to these projections, please refer to the release in our most recent filings with the SEC, including our most recent Form 10-K.

Let me begin with my general comments. I don’t like the fact that we’re losing money, but for the second quarter I’m extremely pleased with our expense management and our gross margin performance exceeded our expectations. In spite of the difficult circumstances we’ve made a great deal of progress over the last two quarters on many fronts, and our second quarter financial results were better than we thought they might be when the fiscal year began. I’m very proud of how the Saks team has been remarkably nimble in shifting focus from a high growth business to this declining sales environment. Although our current financial results do not necessarily reflect the benefits of all of our strategies and investments, we continue to believe that these are the right ones for the future and that they will position us to win in the long run, especially when we return to a more normalized economic environment.

We’ve diligently managed inventories, expenses and capital spending throughout this challenging period and are making adjustments to our strategies. Additionally, we’ve made some adjustments to our capital structure to give us even more flexibility going forward. Ron and I have talked a lot about our four legged stool approach to the business which refers to merchandising, the customer experience, marketing and expense management. We’re certainly making a lot of headway in each category, but given the nature of luxury retailing it takes time before the benefits of certain merchandising marketing and service changes are realized. Conversely, we’re seeing immediate benefits from our expense reduction efforts and this area has clearly been one of our biggest accomplishments to date. Ron will talk more about our merchandising, service and marketing initiatives in just a moment, but first I want to make some additional comments on expenses.

The entire organization has embraced diligent expense control and is literally challenging every expenditure. I’m really pleased with how the team has approached and embraced right sizing the organization and cost structure to the smaller sales space. When business trends began to dramatically worsen last fall, we reduced SG&A by approximately $50 million in the second half of last year, and by another $77 million in the first half of this year. This $127 million of SG&A reductions substantially exceeded our expectations. The decrease not only reflects our reduction in force and lower store selling payroll which flexes with sales, but includes cuts in essentially every area of the business from travel to supplies to benefits to marketing to information technology. No expense is sacred. The cost reductions are significant.

However, we are being very protective of areas that directly impact the consumer as we continue to place the utmost importance on further enhancing our customer experience. We’re continuing to look for additional reductions, although the vast majority of the cuts have already been realized.

Now I’ll ask Kevin to comment on our operating results and the balance sheet.

Kevin Wills

Thanks Steve and good morning everyone. We recorded a net loss from continuing operations of $54.5 million or $0.39 per share in the second quarter. This compares to a loss from continuing operations and before certain items of $29.9 million or $0.22 per share in last year’s second quarter. For the six months we recorded a net loss from continuing operations of $59.4 million or $0.43 per share. For the prior year six months, Saks recorded a net loss from continuing operations and before certain items of $10.9 million or $0.08 per share. There were no call outs or certain items during the current year second quarter or six month period, but there were some in the prior year which were outlined in the release. As we discuss the numbers today in comparison to the prior year, the prior year numbers excluded these call out items.

Comparable store sales declined 15.5% in the second quarter, in line with our expectations. Second quarter comparable store sales benefited from a shift of a spring season clearance event into the second quarter this year from the first quarter last year. Excluding this shift, we estimate that comp store sales would have declined approximately 18.5% for the second quarter. Comparable store sales fell 22.4% for the six month period.

Our Saks Fifth Avenue stores continued to experience weakness across all merchandise categories and geographies. Consistent with the prior two quarters, the sales decline in the New York City flagship store continued to be higher than the company’s aggregate comparable store sales decline. Saks Direct and OFF 5TH are continuing to outperform the company average. Saks Direct posted an approximate 14% comparable store sales increase in the quarter, which also benefited from the aforementioned event shift and an approximate decrease of 3% for the six months compared to increases of approximately 30% and 35% in last year’s second and first half respectively.

Our second quarter gross margin rate was 29.9 compared to 34.6 in last year’s second quarter. This second quarter gross margin performance was higher than our expectation of 27% to 29%. As previously disclosed, we expected a year-over-year decline in gross margin rate for the quarter due to the aforementioned clearance event shift, which accounted for approximately 300 basis points of decline, as well as increased markdowns as a percent of sales. For the six month period, the gross margin rate was 34.4% in the current year versus 36.5% in the prior year.

As Steve noted, managing SG&A expenses continues to be a top priority. We were able to reduce year-over-year SG&A by approximately $33 million in the second quarter, an approximate 18% decrease which was well ahead of our expected reduction of $15 million. As a result we’ve leveraged SG&A during the quarter, even on declining sales. SG&A was 27.6% of sales during the quarter compared to 28.6% in the same period last year. For the six month period we’ve reduced year-over-year SG&A by approximately $77 million.

Primarily due to the sales and gross margin rate decline, the company’s operating loss widened to $67.7 million in the current year second quarter from $40 million operating loss in the same period last year. On a year-to-date basis the operating loss totals $65.5 million compared to operating income of $2.7 in the prior year.

Inventories at the end of second quarter totaled approximately $670 million, down approximately 18.1% on a comparable stores basis from last year’s second quarter. This decline was slightly better than expected and it was modestly affected by the timing of some merchandise receipts. We are pleased with where our inventory levels were at the end of the quarter.

At quarter end the company had approximately $12.5 million of cash on hand, and $85 million of direct outstanding borrowings on its revolving credit facility. As a reminder, our revolving credit facility is secured inventory receivables and does not mature until September, 2011. The company is subject to no financial covenants unless revolver availability falls below $60 million. At that point the company is subject to a fixed charge coverage ratio of at least 1 to 1. As we reduce our aggregate inventory levels throughout 2009, the capacity on the revolver will periodically fall below $500 million, the maximum amount of the revolver. We ended the second quarter with total capacity of approximately $400 million on the revolver due to our reduced inventory levels. Based on our operating plans and cash management actions, we expect to have ample availability on our revolving credit facility throughout the year and do not expect to be subject to the fixed charge coverage ratio at any time during the year. We continue to expect that we will be free cash flow positive for 2009.

During the second quarter the company completed $120 million, 7.5% convertible notes offering. The net proceeds were approximately $115.4 million were used to pay down our revolving credit facility. A portion of this convert along with a portion of the existing $230 million, 2% convert have been classified as equity in accordance with FASB Staff Position APB Number 14.1, which requires that issuers of such instruments separate the account for the liability equity components in a manner that will reflect entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.

During the quarter, the company repurchased 23 million of the 7.5% senior notes due December, 2010 at a slight discount, realizing an approximate $800,000 pretax gain on early extinguishment of debt. The company’s remaining senior notes total $169.3 million and mature as follows, $22.9 million in December of 2010, $141.6 million in October of 2011, $2.9 million in December of 2013 and $1.9 million in February of 2019.

We believe our existing debt facilities provide ample flexibility, with no short term maturities of senior debt. Funded debt including cap leases, borrowing on the revolver, our senior note and the debt and equity components of convertible notes at August 1, 2009 totaled approximately $663 million and debt to cap was 42.4% without given effect to cash on hand.

During the quarter we filed a universal shelf registration with the SEC permitting the company to issue securities in one or more offerings, with a maximum aggregate offering price of $400 million. The shelf covers a variety of securities including common stock, preferred stock, warrants and debt to securities. The filing, which became effective last week, will allow us to quickly access the public market if and when funds are needed. Consistent with our policy, we will not comment on our preference for particular securities or when or if we will issue any security.

We believe the combination of the recently issued convertible notes, the effective shelf registration statement, valuable and unencumbered real estate and free cash flow generation in 2009 will provide the company with flexibility regarding any potential future capital needs.

Let me now turn the call over to Ron Frasch to give you an update on merchandising, service and marketing initiatives. Ron?

Ronald Frasch

Thanks Kevin. It appears that the climb in shopping frequency and spending may be leveling off. The sales trends are not yet on the rebound. As we noted on last quarter’s call, we conducted extensive consumer research earlier this year. And what did our customers tell us?

Research showed that our customers still love to shop, they love brands and they love Saks Fifth Avenue. A strong majority of consumers are unwilling to trade down quality, but are shopping less frequently and/or on sale. They are making investments in versatile items and more carefully considering their purchases. Value is paramount. Personalized service is more important than ever. So what are we doing to address these findings?

To win in this environment it is more important than ever that we offer differentiated merchandise, a great service experience and innovative and effective marketing. Our nine box grid model will continue to guide us as deliver the right assortment of good, better, best product by store. We must offer high quality, well designed product. The styles must be versatile, timeless, and classic with a twist. In order to provide a distinctive and differentiated product offering we are focusing on two main areas, entry price points and exclusivity.

Our merchants have been instructed that at least some element of each buy must include both entry price points and items that are exclusive to Saks. We are working closely with many of our existing designers and brands to create products at more accessible price points. We will still offer a wide array of products in the best category, but have shifted more of our purchases to the good and better categories. Lower prices on existing brands offer an opportunity for Saks to greatly expand its reach.

Perhaps one of the best examples of both value and exclusive product is our Saks Fifth Avenue Men’s Collection, a new line of high quality men’s wear that is debuting nationwide this month. The exclusive offering is our first ever, comprehensive collection for men, complementing our unparalleled assortment of designer merchandise. Planning for the collection began in 2007 as the value of the euro escalated and prices of foreign merchandise increased.

In the past, the company’s private label program was largely limited to sweaters and other basics. The Saks Fifth Avenue Men’s Collection was designed from the ground up, combining European quality with a moderate American fit. The comprehensive assortment includes clothing, sportswear, outerwear, shoes, dress shirts, ties, socks and accessories. And exceptional workmanship goes into every piece. Even though the collection has been in development for two years, it sure makes a lot of sense in this environment since it provides just what the customer is clamoring for, stand out merchandise at a value.

Another development that we are most excited about is the official unveiling of our women’s designer for on the third floor of the New York store, showcasing over 40 designer shops and the most comprehensive assortment of women’s designer apparel on one floor in the country. This will further set us apart from our competition.

In order to win, we also need to continually enhance our service model. And we are keenly focused on retaining existing customers and acquiring and developing relationships with new ones. Clienteling, strengthening relationships and exceptional service are more critical than ever, and we are continually reinforcing these with improved utilization of our new point-of-sale clienteling systems which allows tailored clienteling. We know that once a customer develops a personal relationship with a sales associate or a personal shopper, they are more likely to increase their dollar spend and loyalty to Saks. We are also emphasizing and training team oriented selling and cross selling.

We are also continuing to make progress in the development of comprehensive by store, local business plan, which will guide the stores in acquiring, developing and retaining customers. Every store is taking ownership of expanding their market share by identifying and focusing on under penetrated customer segments. All stores completed a development of their local business plans in the second quarter and are putting the plans to work.

Our associate population is engaged with each associate task to develop targeted outreach events by tapping into their personal customer base, which often leads to the acquisition of new customers. We are also using our clienteling technology to isolate those customers we haven’t seen in the last several months, in order to reach out to them to schedule an appointment.

Additionally we are mining our data to determine which of our customers may be strong shoppers in select departments but have not shopped in others. This dovetails into our focus on team and cross selling.

So as you can see, we have a lot going on and I would love to invite you in to one of our stores to see for yourself. I think we’re moving in the right direction and have made the critical adjustments in our strategies to position us to thrive in the long term.

Steve?

Stephen I. Sadove

Thanks Ron. Before I talk about our outlook for fall, let me take a minute to update you on our OFF 5TH and Saks Direct businesses.

A couple of years ago we developed our new prototype, OFF 5TH store and embarked on a steady growth plan for this business. Growing OFF 5TH makes even more sense in this environment as customers focus on value. There’s less than 10% overlap between Saks Fifth Avenue and OFF 5TH customers so we’re essentially reaching an entirely different customer base with these stores.

We’ve worked hard to improve the merchandise assortments, with less focus on last season’s merchandise and more on products made exclusive for OFF 5TH. Customers have been very receptive to the changes. Since spring of last year we’ve opened 60 OFF 5TH stores and two replacement stores, with the most recent opening just outside of Cincinnati, Ohio this month.

As Kevin noted Direct continues to outperform as well. We’ve continually strengthened our online merchandise assortments and the marketing efforts. We’ve added more accessible price points from key and emerging vendors for our online assortment and are driving growth in online friendly categories such as Children’s and Gifts.

This year we added international shipping capabilities and we continue to make the website and distribution center enhancements that improve the shopping experience. And there’s more in store for fall. We remain excited about the potential for our direct business.

As we look to fall, we expect that the economic conditions will remain extremely difficult for the balance of the year if not beyond, and we’re continuing to plan accordingly. However, we are reaffirming our prior expectations related to sales, gross margin rate, inventories and capital spending for the balance of the year. And we’re pleased that we’ve been able to make more progress on reducing SG&A than originally anticipated.

Although sales trends are undoubtedly more stable than they were in the fall of last year, the current economic and retail landscape is still uncertain and we know that predicting future sales and gross margin performance with any certainty remains very difficult. Variations from our expected sales trends up or down could materially impact our future results. We outlined our detailed assumptions for the remainder of 2009 in this morning’s press release. Let me go over a few of the highlights.

We still expect a comparable store sales decline of mid to high single digits in the second half of the fiscal year, with the third quarter weaker than the fourth quarter which would result in a decline of low double digits for the full fiscal year. It may appear that we’re expecting a significant improvement in fall 2009 sales trends but keep in mind that our fall expectations are from a lower 2008 sales base. When reviewed against a more normalized 2007 period or a two year run rate, spring and fall 2009 performance is expected to be similar.

Comparable store inventory levels are expected to decrease in the low to mid teen percentage range through the second half of 2009. Based upon current inventory levels, planned merchandise receipt flow approximately 20% lower than the prior year and our promotional calendar and permanent markdown cadence, we expect a substantial year-over-year gross margin recovery in the second half of 2009, with gross margins in the 35 to 37% range. This would bring the full year’s gross margin in the 35 to 36% range.

Absolute SG&A dollars are expected to decline by approximately $10 million in the second half of 2009, bringing the annual net SG&A reduction to approximately $87 million. There are many fixed and variable components to SG&A and the quarterly expense flows can vary, based on the nature of the expense. Substantially all of the SG&A expense reductions have been realized in the first half of 2009 as the company was able to reduce variable expenses commensurate with the higher sales declines in the first half, and as the company laps approximately $50 million of expense reductions that were made in the second half of 2008. Keep in mind that our 2009 SG&A expense reductions are net of several expense increases including an approximate $8 million increase in 2009 pension expense, incremental expenses related to the new OFF 5TH stores, more normalized incentive compensation and certain inflation driven expenses during the year.

Capital spending should approximate $55 million for the full fiscal year, which is a reduction of approximately $75 million from 2008 spending levels. A disproportionate amount of the annual spending, about $46 million, occurred in the first half primarily due to the timing of the New York City flagship renovation on the third floor as well as other investments in New York, as well as the Miami Dadeland store renovations that are essentially complete.

Some store renovations that were on the tentative drawing board have been prudently postponed until the environment improves. We are continuing to execute all necessary maintenance capital spending. Our physical plant is in excellent condition and we are committed to keeping it that way.

We’re taking decisive actions that are putting us on a path of improved operations, and in spite of the environment I’m pleased with the progress that we’re making on many fronts.

At this time we’d be pleased to entertain your questions. Operator, will you start the questions please?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Deborah Weinswig – Citigroup.

Deborah Weinswig – Citigroup

Steve, you talked about OFF 5TH and potential expansion from here. How should we think about that geographically and also would you prefer to do that in markets where you have an existing Saks Fifth Avenue store? If you can just help us think through the kind of future roll out of those stores.

Stephen I. Sadove

Yes, I think there’s a good opportunity for growth in OFF 5TH. It’s performing better than the full line stores, not performing as well as it had been but clearly we’re seeing better trends there. We’ve talked about opening three to five new stores a year. I think we’re on a path this year to a little bit more than that. I think you’re going to see a mix of the traditional outlet malls as well as what I would call more along the lines of freestanding strips centers as representing opportunities for OFF 5TH. From a geographic perspective I see it as being national. We’re opening OFF 5THs across the country, so I don’t see any one region as being predominant.

And as far as within a geography of a full line store, I think we’re open to both ways of doing it. We do have some stores that are proximate to some of our full line stores and we don’t see an impact on one in terms of the full line stores. As I said on my remarks that the overlap is less than 10% and as an example when we opened up the new format Orlando store we saw very little impact on our Orlando full line store. So I think there’s opportunities in some of the existing markets as well.

Deborah Weinswig – Citigroup

I think Ron had spoken about data mining the clienteling system. Can you give us an update on where you are with that initiative and can you also just give us an example of some concrete wins?

Ronald Frasch

On the clienteling system that we have?

Deborah Weinswig – Citigroup

Yes.

Ronald Frasch

You know it’s a web based clientele system where the associate can communicate directly with their clients online from the PLF station. They’re also able to pull down photographs of everything that we have photographed in the company to be able to use that as an attachment to send to customers such as a recommendation to buy something.

What we do is we’re measuring, we put all of our sales associates through a training program and they’re all being managed on a level. We’ve got four levels of skill set that we’re managing to. And all of the department managers and store management in our stores have to spend a good part of the day on the selling floor, developing and managing these associates conquer to behavior to clientele better with the consumers.

And there’s been, Deborah, numerous success stories. I mean we get a list actually every Sunday. We get a very thorough list of great success stories from the prior week and it’s very gratifying because we’re seeing a real change in the behavior of our selling community.

Stephen I. Sadove

I think I’d echo Ron’s comments, Deb. I think it’s transformational in terms of the behavior that it’s creating in the organization. Specifics would be customers in terms of increasing their crush up patterns. What we’re looking at in terms of customers that haven’t been in the store, in a recent period of time we’re able to communicate more frequently with them. It’s the associate having at hand the information and being able to act upon it, making a real difference.

Deborah Weinswig – Citigroup

Ron, you’d also spoken about adding more products at more accessible price points and also you touched on private label. Can you just update us maybe on where you are versus a year ago? And how should we think about this initiative going forward?

Ronald Frasch

Well the private label initiative I spoke to, Deb, is the Men’s Collection, called the Saks Fifth Avenue Men’s Collection which is a very [farrow] product offering across all men’s categories, which is launching officially this month. We’re very excited about it. We think that over time it’s going to become a very important penetration within our women’s business category.

Relative to working with the brands, we’ve been working since the end of last year with most of our brands on the development of products that fit within either zones of business that they have been very successful with or that are exclusive to us in commercially priced zones of business. Now this is not just working with bringing new brands in. This is working with our existing line up of brands and trying to make their product offer more accessible to our consumers.

Operator

Your next question comes from Christine Chen - Needham & Company, LLC.

Christine Chen - Needham & Company, LLC

I was wondering if you could comment about the contemporary space, what’s working there, what’s not working. In particular premium denim, is price point an issue? Is fashion still selling better than basic?

Ronald Frasch

The contemporary zone I know has been written quite a bit about recently. It’s been a more challenging zone. It seems like we’re making some very good headway and I’m very pleased with it. And what we see performing for us is probably the most fashionable zones of that business. So within denim, the denim that’s performing well is the most fashionable denim. Within the apparel area, it’s the most fashionable and trend driven product. The brands that are performing the best are the brands that really have stayed on top of trend. So we have you know set up a very regular schedule of trend shops in each of our contemporary departments throughout the company, and we buy into the trends and work with the brands that create the trends for us. We’re feeling very positive about where we’re heading here.

Operator

Your next question comes from Ben Rowbotham for Adrianne Shapira - Goldman Sachs.

Ben Rowbotham for Adrianne Shapira - Goldman Sachs

Quick question on your SG&A. Given all the cost out that’s been put in place, what do you think your leverage point is now on a normalized basis?

Stephen I. Sadove

Kevin, do you want to take that?

Kevin Wills

On a go forward basis we’re still attempting to find additional cost reduction activities. We talked about that. We’re continuing to look at all aspects of the business, but we believe the vast majority of the cost reductions in SG&A have been realized. On a go forward basis you know we would still anticipate hopefully being able to leverage SG&A in the low single digit range.

Ben Rowbotham for Adrianne Shapira - Goldman Sachs

And then I believe Ron spoke to some stabilization in terms of the comp trends. Has that been more from a traffic perspective [or] conversion? Can you break that down a little bit, please?

Ronald Frasch

Clearly traffic has been down. I think that you saw traffic down substantially in a double digit range early in the year, probably seeing a little bit of stabilization in that rate but I don’t see materially having improved dramatically. So your transactions are down, your [AE Water] has not gone down. That’s been relatively stable.

Ben Rowbotham for Adrianne Shapira - Goldman Sachs

I believe one of the first questions was about mix shift across good, better, best. Is there any way you can quantify that?

Stephen I. Sadove

If I were talking broadly about it and its hard to give specific numbers because one person’s good is going to be another person’s better, but if we were tracking at maybe a third, a third, a third between good, better, best we’ve probably shifted the best component to the 25% range and shifted that into the good better. We’re not talking about and I’d be very worried if someone misinterpreted it in terms of hey that we were getting out of the best component or that we were moving down brands. A lot of it is within the brands in terms of the mix of how we shifted the price points within the individual brands, but it’s that kind of changes.

Operator

Your next question comes from Charles Grom - J.P. Morgan.

Charles Grom - J.P. Morgan

You know six months ago having positive EBITDA this year seemed almost impossible and now it looks like that’s going to happen. In fact you know we have roughly $60 million in our model. When we look at 2010 most of the street including myself have you guys losing money. I just wondered if you could sort of elaborate on what would have to materialize in order to make money next year when we look at net income.

Stephen I. Sadove

I think it’s a little bit premature to be giving any kind of forecast for 2010. We’re obviously planning it right now, making our decisions as it relates to spring buys. And we’re continuing to be very cautious relative to the environment for 2010. We’re not expecting to see a rapid turnaround in the consumer. I think that our focus at this point is to continue to control what we can control very aggressively, and that’s the expenses, it’s the merchandise, the capital. And we will do that in this environment. As it relates to whether or not we’ll make money in 2010, what the specifics will be, I’d really rather wait until we get a little bit closer to 2010. But we’re not going to get ahead of ourselves relative to inventory receipts or assumptions.

Charles Grom - J.P. Morgan

Just on the CapEx front, $55 million for this year, how much is that maintenance? Is that $25 to $30? I think it is. And then just off that, what are you guys thinking about store growth for next year and along the lines of what should we think about for CapEx next year as well?

Stephen I. Sadove

I think you’ve got the numbers about right. If you use that $25, $30 million as being maintenance capital and maybe it’s somewhere in that range. You know our store base is in pretty good shape. There’s the biggest components of this year’s spend are the finishing up of the New York renovations, primarily the third floor, as well as we had a renovation in Miami-Dadeland. As we look into next year you’re not going to see built into the plan a lot of major renovation so we’re thinking that the capital spend’s going to be closer to that $30 million type number. I’m not going to give specific guidance yet, but you won’t have the number of the $55. It’ll be substantially lower than that, closer to the maintenance capital that’s required.

We have two new stores that we’ve signed letters of intent for on the full line side. One of them is outside of New York City and lower Westchester called Ridge Hill and one in San Juan, Puerto Rico. You know we’re still doing a lot of due diligence work related to whether those occur. There are a number of hurdles [audio impairment] we still have to get through to make sure that they [audio impairment].

And a lot of those are developer funded relative to the capital, so from the store expansion on the full line I’d be looking along those are potential openings. And then in the OFF 5TH as we talked earlier we have a target of three to five new stores a year, so we’ll continue to expand on the OFF 5TH. Again those tend to be developer funded as well.

Charles Grom - J.P. Morgan

Last question just on the merchandising front but the launch of the Saks Fifth Avenue Men’s Collection is there anything that you guys are [audio impairment] for spring of next year on the private and exclusive line, to build off of it the launch this month?

Ronald Frasch

There will be an expansion of that program, but what we’ll do is just continue to develop it. Other than that we have some things we’re working on. That is correct, but I’m not going to communicate them at this point.

Stephen I. Sadove

And Ron has a lot going on on the women’s side as well, beyond the men’s.

Ronald Frasch

Nothing that we’re prepared to discuss.

Operator

Your next question comes from [Rob Davis – Unidentified Firm].

[Rob Davis – Unidentified Firm]

Actually my questions have been answered. Thank you.

Operator

Your next question comes from Michelle Clark – [Unidentified Firm].

Michelle Clark – [Unidentified Firm]

Any notable changes in consumer behavior sequentially and specifically do you have the percent of full price selling in Q2 and how that compared to first quarter of this year? And my second question is sourcing. How should we be thinking about sourcing related gains in the back half of the year?

Stephen I. Sadove

I think in terms of the consumer behavior, I don’t see material changes going on. Clearly you’ve seen some degree of you know if you look at first quarter trends versus the second quarter trends, it was slightly improved in the second quarter. So you know you had a little bit of [inaudible] but if I were to look at it on a full price selling basis, the trends in the first and second quarters weren’t that different. So you know where you saw a little bit of the improvement was more driven by the higher degree of markdown selling in the second quarter, which so you saw the trend improvement but I don’t see the consumer appreciably changing in terms of their behavior.

If I understand the second question in terms of lower supply, that would be driven by our lower receipts. If I understand what you’re asking about which is we purchased quite a bit less product going into the fall so the supply demand situation is getting much much more in line. We came into the fall season with a minus 18 comp inventory and so we looked at our demand in the fall where we’re talking about high to mid single digit declines. You have much more alignment relative to supply demand if we’re talking about that kind of supply.

If you’re talking about sourcing, you know we don’t self manufacture essentially very little if any of our products. So it’s mostly from a vendor perspective.

Operator

Your next question comes from Lorraine Hutchinson – [Unidentified Firm].

Lorraine Hutchinson – [Unidentified Firm]

Can you discuss some of your marketing plans for holiday, if there are any changes there? And then how do you expect to drive full price selling and traffic through that important season?

Ronald Frasch

We haven’t made any material changes to our fourth quarter strategy. And quite frankly our most focused objective in driving traffic into the stores is through the individual stores, the local business plans which I addressed during my remarks. We think the most effective way to drive our customers into the store is to have our sales associates take the lead on it and have our general managers take the lead on it. So our local marketing efforts are being significantly ramped up.

We also will be very obviously much less promotional. We have no intent to repeat last four quarters promotional initiatives. We’ve worked very hard on getting key price points flowing in and I think that we see our inventories as being much more classification, item oriented because that’s how the consumer is buying and we reacted very well to it.

Stephen I. Sadove

Yes, I think in terms of the promotional environment for the fall as Ron is saying you know there’s much closer alignment in terms of supply demand and your question as it relates to full price selling, you know if you think about what luxury marketing’s all about, it’s always been about limited distribution, limited quantity, limited supply of product. And we’re moving back in that direction as we have a limited supply, or we’ve limited more of the supply of product and you’re going to see if you want to get it and you want to get it in your size you’re going to have to buy it. And I think that we’re starting to create that mentality again.

Operator

Your next question comes from Robert Drbul – [Unidentified Firm].

Robert Drbul – [Unidentified Firm]

The two questions that I have is just want to go back to the entry price points. Is there a number that you could share on entry price point offering, you know expected penetration versus the last year’s numbers in terms of how you’re changing the mix? And the second question is you talked about the cost spread of the New York City business versus the rest of the chain. Is that trend narrowing at all or could you talk a little bit more about the trend versus the last couple of quarters?

Ronald Frasch

Let me take the price point situation, Bob. You know I’d love to give you a number but right now we’re not able to. We are working one by one, buyer and brand, identifying what those opportunities are. We presented to the brands what our needs are, but we have a pretty clear base by brand of what our needs are but it’s really way too early. And it’s almost a by brand situation about what penetration their opening price point should be, their good price level should be. So I can’t really help you out with that.

Regarding the trend of the New York store, we don’t see really any change in the trends between what’s happening outside of New York and what’s happening here in New York.

Robert Drbul – [Unidentified Firm]

Thank you very much.

Stephen I. Sadove

If you were to look early in the year versus now, it’s not that different a trend. It’s under performing and the trend hasn’t shifted dramatically.

Operator

Your next question comes from [Karoo Martinson – Unidentified Firm].

[Karoo Martinson – Unidentified Firm]

Just trying to look at the gross margins here that came in better than expected and I’m just trying to reconcile that with the people shopping less often and focused on sale items. I mean what were some of the drivers that had them beat everyone’s expectations?

Stephen I. Sadove

Basically we’re trying to back off somewhat on the promotions. We’re a little bit less promotional than we had thought we would be and we’re getting a little bit better in terms of supply and demand. So we’ve pulled some of the items out of promotion. We’re promoting a little bit less frequently and it’s driving the improved gross margin performance.

[Karoo Martinson – Unidentified Firm]

Historically I think we’re kind of at the low point of the borrowing base, but if I’m hearing your comments correctly we should see that borrowing base tighten a little bit going forward. Correct?

Kevin Wills

As I said earlier we had about $400 million of capacity at the end of Q2. As we move throughout the third and fourth quarters we ramp up inventories for the holiday season, you would see that capacity naturally increase on the third quarter and then naturally start decreasing as we move into the fourth quarter. That’s the natural working capital flow.

[Karoo Martinson – Unidentified Firm]

So it will still follow the natural pattern.

Kevin Wills

That’s correct.

Stephen I. Sadove

I think what Kevin indicated was we feel very comfortable relative to our ability as well as you know in terms of our needs.

[Karoo Martinson – Unidentified Firm]

Just lastly on the SG&A savings, another $10 million for the second half. I mean should we expect that kind of evenly split or how should we look at that?

Ronald Frasch

Generally yes.

Operator

Your next question comes from Todd Slater – [Unidentified Firm].

Todd Slater – [Unidentified Firm]

I just have a quick follow up to Ron on his commentary on sort of what’s performing. Ron you said the best performing brands in the denim areas are those that are pursuing sort of the more fashion and trend type styling. I’m wondering if True Religion would fall into that category?

Ronald Frasch

Really Todd I would prefer not to give any individual brand’s performance.

Stephen I. Sadove

Next question?

Operator

Your next question comes from [Jason Trahio] for Emily Shanks – [Unidentified Firm].

[Jason Trahio] for Emily Shanks – [Unidentified Firm]

On the SG&A cost reductions, can you give us a sense for how much of the reductions are permanent just being related to declining sales?

Stephen I. Sadove

Well I think you have a combination of both that are going on. Clearly the piece that flexes, you know the commission base that flexes with sales, as sales go back up that’s going to increase. I think a lot of the other pieces are you know much of that is going to be permanent. You know we’ve taken a lot of heads out of the company, you have some permanent reduction in terms of the ways that we do business. There are some pieces that over time as business improves we may have to flex up a little bit. For example we eliminated the 401(k) match. I would anticipate that as business improves you’re going to see some reinstating of some form of the 401(k) match. So there’s some elements that are going to go back in, but most of it that wasn’t the variable piece I think is permanent and we’re continuing to look for more savings that are not customer, you know affecting the customer experience.

[Jason Trahio] for Emily Shanks – [Unidentified Firm]

So would you say then of the total cost savings and that you expect to achieve by year end, are half of those about permanent or is it more like three-quarters permanent versus the variable component there?

Kevin Wills

We’re not going to break out a specific percent but you know in the 50% range is in the good general area that you could orient yourself to. As Steve indicated some of these I would fix as maybe short term fix and the 401(k) is an example. As we see business improving, we would anticipate maybe adding that expenditure back. So that’s how we’re viewing it now and as Steve also noted we’re continuing to look for additional opportunities.

Ronald Frasch

As we do this we’re learning that we can do with less in some areas. We’ve changed I think permanent fixes, consumers have changed some of their behaviors we’re changing our behaviors in areas like purchasing and travel and every item of expenditures.

[Jason Trahio] for Emily Shanks – [Unidentified Firm]

Just lastly, you commented that you’re seeing weakness among all geographies. Can you give us a little bit more color on that as far as are you seeing any variability you know by region or are certain regions doing better than others? You know outside of the New York City store, just in general throughout the country.

Stephen I. Sadove

New York is primarily the weakest. I don’t see a definitive pattern geographically. I could maybe argue that Texas is a little bit better than some of the other geographies, but if I were to look at the West Coast or Florida I don’t see an appreciable difference. And we’ve looked at things like the markets that are hardest hit in the housing, you know the Las Vegas’s and the Phoenix’s of the world and I don’t see material differences in their trends versus the aggregate.

Operator

Your next question comes from Dana Telsey – [Unidentified Firm].

Dana Telsey – [Unidentified Firm]

Any updates on your thoughts on the sale lease back and thoughts there? And also any other details on category performance related to gross margin or what you’re thinking about going forward, whether its jewelry, designer, shoes or women’s? And just the new designer floor, I’ve seen it evolve over the past few weeks, it looks terrific.

Stephen I. Sadove

In terms of each of the pieces, category performance we have seen weakness I would call weakness across all of the categories. Shoes and handbags actually popping I think starting to pick up a little bit versus they had been very weak earlier in the year, shoes especially seems to have started to stabilize. Cosmetics is always a little bit less volatile in this kind of environment so cosmetics has been a little bit of an over performer versus some of the other categories. So that’s how I would categorize that.

The lease back, look, I feel very good about the work that Kevin and the team have done relative to managing the balance sheet, feel very good about the convertible debt offering that we did and that I think gives us an enormous amount of flexibility. We just put in place a shelf registration statement that gives us further flexibility to do many different kinds of financing. Sale lease back is one of many different kinds of things. It’s just that we do have some limitations in terms of the amount of sales lease back that we can do. Its $50 million plus half of a prior year’s $50, so we can do $75 if we wanted to. I think it remains to be seen whether that’s the best tool for us to be using. And so we’ll just have to look at that along with other things.

If we need to be doing anything. So you know I think in Kevin’s comments he made a comment and said that if and when we need to do something and I think that if is an operative word as well as when.

And as far as the third floor, I’ve got to tell you we opened up the last of the shops today and the thing absolutely looks spectacular. It truly is the finest luxury designer floor in the United States and we’re excited for everybody to see it. Did you have a follow on, Dana?

Dana Telsey – [Unidentified Firm]

No, that was it. Thank you.

Operator

Your next question comes from Paul [Nury – Unidentified Firm]. Your line is open.

Stephen I. Sadove

Just go to the next.

Operator

Your next question comes from [Jeff Kobelars – Unidentified Firm].

[Jeff Kobelars – Unidentified Firm]

I was curious about your guidance for the second half of the year and the gross margin. You’re expecting the 35 to 37% in the second half and that compares to last year’s second half of 28%. I’m just curious about how much of the improvement in gross margin you’re expecting for the second half will come from eliminating the severe discounting that was done in the fourth quarter as opposed to how much you’re expecting gross margin improvement from more full price selling?

Kevin Wills

Yes, it will come from a combination obviously. We have not broken out or provided guidance relative to our quarterly gross margin flow but with Saks historical performance you should expect to see a higher gross margin in Q3 versus Q4, and different legs to the year-over-year change we’re expecting improvement in both quarters. With much larger improvement in the fourth quarter because of the discounting that went on last year that we do not anticipate having to repeat.

[Jeff Kobelars – Unidentified Firm]

At the start of the call Ron you talked about some customer research and I was curious if some of that research touched on when customer will start to get back to their old way of spending what they need to have to see before they will continue to spend it at their old rates. You know the S&P’s up 9% year-to-date and Steve you had talked about how there’s a high correlation of the stock market with your sales. It’s not showing up yet but do you have any general thoughts about that?

Stephen I. Sadove

Let me make a couple of comments and then maybe Ron wants to jump in as well. The research really was not focused on when they’re going to start shopping again. It was much more focused on what are they looking for? How are they thinking about brands? How are they thinking about our brand and shopping and the experience and what their expectations were. And it was enormously helpful to us because it reinforced the fact that they like to shop, that they like shopping at Saks and the experience at Saks and they like brands and the brands that we carry.

But they were looking to trade down within the brands that we carry. As it relates to our expectations of luxury, I do believe that luxury will recover over time. And that long term the secular trends of luxury are favorable. The linkage to the stock market I think as much as anything, and there is a clear correlation, part of it has to do with it’s a confidence and comfort level. You know we’re still down roughly 35% or so, 35 or 40% from the peak on the S&P. And part of it has to do with a belief in terms of have we hit bottom? Is it real? Are we in a L or are we in a W relative to what’s going to be happening to the market? And how comfortable does the consumer feel that we’ve recovered in terms of the curve? And until you get the psyche of the customer feeling that they’re comfortable with their environment, with where it’s going in the future, I think there’s still going to be some instability relative to the behavior in the near term.

Having said that, longer term I still feel very good about the sector.

Operator

Your last question comes from [Michael Shredguess – Unidentified Firm].

[Michael Shredguess – Unidentified Firm]

I was just wondering, can you guys talk about you know you introduce these private label brands, are you looking to attract more customers who previously haven’t shopped with you? Or are you looking to increase the amount of purchases by existing customers?

Ronald Frasch

Good question. It’s really all of the above. We want to make sure that we have accessible entry level price ranges for consumers, that the quality standards effects existing offerings. At the same time we have consumers who we have noted have traded down. So we think that the zone which is really a men’s initiative at this point we’ll be able to service these clients that we anticipate. So it also helps to attract new people and will allow people to buy more than they would have bought. I mean they want to buy a couple of shirts for a couple hundred of dollars or a pair for $100 it’s a good deal. So we’re looking at it in that manner.

[Michael Shredguess – Unidentified Firm]

With regards to the number of commissioned sales people you generally have on average in your stores, how much have they been reduced? And I guess at what point do you start to think or what will be the sign in which you’ll start adding people? For example in the fourth quarter will you start to add sales people for the fourth quarter?

Stephen I. Sadove

I think first of all it varies from store to store in terms of the staffing levels. And what we’ve done is try to understand what’s the appropriate level of staffing that is one going to first and foremost allow the customer to get an appropriate experience. And we focus very much on how we’re approaching customers, how we’re welcoming, how we’re giving them the kind of experience we want them to get at Saks. We also want to make sure that our associates are making a good living and that they’re able to make enough money.

If we flooded the floor with sales people at a lower consumption rate, then the people aren’t going to be able to make an acceptable living. And that’s not where we want to be. So it’s a balancing of having the right number of people on the floor. We monitor that very regularly and you know as the business picks up, then we’ll re-address it. If you look at the number of people on the floor today it’s appreciably less and it varies again from store to store, but it’s appreciably less than we were a year ago. And that reflects the smaller business that we have.

But again the important point is we start with what we need to do to make sure we’re servicing the customer.

[Michael Shredguess – Unidentified Firm]

In regards to CITD, do you know what exposure your suppliers have to CIT and if issues get worse with CIT do you have contingency plans to deal with that?

Kevin Wills

We don’t know the exact percentage of our vendor base that uses CIT because we don’t have insight into our vendor’s capital structure and sources of funding. I would note.

[Michael Shredguess – Unidentified Firm]

A number of your competitors just cut straight checks to CIT sometimes, but usually it’s about 10 to 15% of their suppliers.

Kevin Wills

There are certain suppliers that we also cut checks straight to. There are also suppliers which we believe we pay directly then remit on to CIT. So again I don’t know what the aggregate number would be.

I would note however that the CIT exposure issue has been out now for several months, so I would presume that vendors have lined up alternatives to CIT should they need that. I would also note that the credit markets are certainly more open today than they were probably six months or so ago. So the combination of those two factors, it would be my expectation that vendors will be able to secure alternate financing if they ever need to.

Stephen I. Sadove

I agree of course that we have not had delivery issues or anything affecting us as it relates to the CIT.

[Michael Shredguess – Unidentified Firm]

Do you get the sense that you would shift more or you’d have the opportunity to shift more of your orders to existing larger vendors if some of the smaller vendors encounter any issues?

Ronald Frasch

This is Ron. You can’t really move orders that quickly. And in all probability if a vendor went out of business then yes we would look how we needed to offset that volume and service that customer. But we are constantly evaluating and keeping our ears very close to the ground what’s happening out there.

Stephen I. Sadove

Yes, in the normal course of Ron running the business we have vendors, you know if we’re cutting our receipts 20% some vendors were being eliminated, some were growing and some were being cut 50%. So in the normal course of the business you’re going to be doing some of that moving around anyway.

Operator

And there are no further questions at this time.

Stephen I. Sadove

Well thank you all very much and we look forward to speaking to you next quarter.

Operator

This concludes today’s conference. You may now disconnect.

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Source: Saks Incorporated Q2 2009 Earnings Call Transcript
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