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Men's Wearhouse (NYSE:MW)

Q3 2010 Earnings Call

December 7, 2010 5:00 p.m. ET

Executives

Ken Dennard – IR Counsel

George Zimmer – Chairman and CEO

Neill Davis – EVP, CFO, Treasurer and Principal Financial Officer

Doug Ewert – President and COO

Analysts

Ike – JP Morgan

Janet Kloppenburg – JJK Research

David Mann – Johnson Rice

John Kiernan – Cowen & Company

Operator

Good evening, ladies and gentlemen. Thank you for standing by. Welcome to the Men’s Wearhouse third quarter 2010 earnings conference call. [Operator Instructions.] This conference is being recorded today, Tuesday, December 7, 2010. I would now like to turn the conference overt to Ken Dennard with DRG&L. Please go ahead sir.

Ken Dennard

Thank you and good afternoon everyone, and welcome to the Men’s Wearhouse third quarter 2010 earnings call. Today’s call with management will cover review of the third quarter results, and fourth quarter financial guidance, followed by a Q&A session.

Please note management will be making a number of forward-looking statements today, and all such statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions mentioned today, due to a variety of factors that affect the company, including the risks specified in the most recently filed Form 10-K and 10-Q. Also, I'd like to say this call is copyrighted material of Men’s Wearhouse and cannot rebroadcast without our written consent.

I’d now like to turn the call over to George Zimmer, Chairman and Chief Executive Officer. George?

George Zimmer

Thanks Ken, and good afternoon everyone. The year-to-date results that we reported today of a 7.5% increase in total sales, and a 20% increasing GAAP operating income, are a reflection of many strategic and operating initiatives, the groundwork of which was developed at the beginning of fiscal year 2009. While Neill and Doug will touch on those in their prepared remarks today, I do want to call your attention to our marketing and promotional efforts.

At Men's Wearhouse stores, we introduced a new television campaign and promotional offers, with impressive results, specifically a 9.6% comparable store sales increase for the quarter, which was on top of a strong performance in the prior year quarter. Our strategies for the fourth quarter as well as into fiscal 2011 will be to focus our television spend on compelling offers that drive traffic and volume at acceptable margins.

Year-to-date, the mix of total customers shopping Men's Wearhouse is 52% existing and 48% new, but new customer traffic is up 5% over the prior year. Based on these results, it's our expectation that this marketing strategy, which has been running for the last three months, will enable us to reduce the level of annual marketing expenses in fiscal 2011 by up to $10 million across all divisions, including K&G and Moore's, although the results at K&G and Moore's are not as robust as Men's Wearhouse. And also, we're increasing our focus to mine the database of our 15 million customers in our three loyalty programs to more effectively target offers that encourage additional visits and increased share of closet.

And finally, an aspect of our business that I want to briefly touch on concerns our capital allocation strategies. For those that have followed the Men's Wearhouse since going public in 1992, you are aware that over the years we have maintained a conservative fiscal discipline which is most evident in our capital structure and levels of liquidity. Those strategies have enabled our company to continue to pursue long-term growth largely unabated due to cyclical downturns. The result? A compounded annual growth rate in top and bottom line in excess of 10% since going public 18 years ago.

Our first priority is to ensure that we maintain the capacity to add to our businesses, such as the recent acquisition of Dimensions and Alexandra in the United Kingdom for a cash consideration of approximately $100 million. Second, to fund an ongoing reinvestment program within our store base, whether it be new stores or remodels, to remain current in the mind of the consumer. And lastly, to maintain a level of operating liquidity in the range of $200 million, which for our asset size we believe is appropriate.

At the same time, we are continuing to generate high levels of free cash flow, and to the extent we find ourselves in an excess capital position, we have and will continue to return that capital to our shareholders through our dividend programs, maintaining maximum flexibility for the company.

Before I turn the call over to Neill, I want to comment on the efforts of our employees in our stores and distribution centers. The changes we made in our promotional strategies and the ongoing growth of our tuxedo rental business have placed significant additional burdens on everyone.

Our employees have responded exactly as I would have hoped, with a can-do attitude that continues our emphasis on exemplary customer service, doing whatever it takes to make the customer experience extraordinary. I truly believe that this level of customer service is a significant reason for our current success in our tuxedo rental business.

Now I'll turn the call over to Neill for details of the third quarter.

Neill Davis

Thanks George, and good afternoon everyone. Total company sales increased 19.1% for the quarter. Sales at our retail stores increased $36.3 million, or 7.9%. This was due mainly to a $20.1 million increase in retail apparel sales and a $13.6 million increase in tuxedo rental revenues.

Comparable store sales at our Men's Wearhouse branded stores and at Moore's increased 9.6% and 5.6% respectively. These gains were due mainly to increased units per transaction and higher store traffic levels, which more than offset a decrease in the average transaction's value, as well as continued unit growth in our tuxedo rental business. At K&G the decrease of 20 basis points in comparable store sales was due mainly to a decrease in the average transaction value.

Tuxedo rental revenues as a percentage of total retail segment net sales increased from 21.3% in the third quarter last year to 22.5% in the third quarter of this year. In absolute dollars, tuxedo rental revenues increased $13.6 million or 13.9%, due mainly to an increase in paid units rented offset partially by lower average rental rates in the United States.

Net sales at our corporate apparel segment increased $51.8 million to $55.5 million for the quarter. $50.6 million of this increase was due to our acquisitions of Dimensions and Alexandra in the U.K. and the balance of the increase was related to our domestic corporate apparel business conducted through TwinHill.

Total gross margin as a percentage of total sales decreased 101 basis points, from 43.7% to 42.7%, due primarily to more aggressive promotional offerings in fiscal 2010 compared to the prior fiscal year and the increased mix of the lower margin corporate apparel business.

Product margins within our retail apparel business declined 265 basis points due to our more aggressive promotional cadence. However, our overall retail segment gross margin as a percentage of related sales increased 64 basis points to 44.5% in the quarter, primarily due to a higher mix of tuxedo rental revenues and a decrease in occupancy costs. Occupancy costs decreased as a percentage of retail segment sales by 185 basis points from 15.8% to 13.9%.

In our corporate apparel segment, gross margin as a percentage of related sales increased 393 basis points to 26.5% in the third quarter of 2010 due to our acquisitions of Dimensions and Alexandra in the U.K.

Selling, general, and administrative expenses were $200.6 million, an increase of 16.2% from the prior year's SG&A, up $172.6 million. During the quarter we incurred $1.4 million in acquisition transaction and integration costs, $2 million in tuxedo distribution closure costs, and $3.2 million for non-cash asset impairment charges related to 40 Men's Wearhouse and Tux stores, some of which were partially impaired in the prior year.

Excluding these costs, third quarter SG&A expenses were $194 million, or an increase of 12.4% to the prior year quarter. Selling, general, and administrative expenses related to the acquired U.K. operations resulted in a 6.6% increase. The remaining 5.8% increase is primarily due to increased marketing and increased employee benefit costs. As a percentage of total sales, adjusted SG&A decreased 210 basis points from 37.4% to 35.3%.

Operating income for the quarter was $34.4 million. Excluding $1.4 million in acquisition integration costs, the $2 million in tuxedo distribution closure costs, as well as the $3.2 million in non-cash asset impairment charges, operating income was $41 million, or 7.5% of total net sales compared to operating income of $29.4 million, or 6.4% total net sales for the prior year period last year.

The effective tax rate of 25.7% for the third quarter was lower than the prior year quarter due to favorable tax rate effects from the release of valuation allowances related to foreign tax credit carry-forwards as a result of our acquisitions in the United Kingdom as well as recognition of previously unrecognized tax benefits and relayed accrued interest from expiration of statutes of limitations, offset partially by the effect of state income taxes.

From an inventory perspective, retail segment inventories declined 6.9% from prior year levels and inventories from our corporate apparel segments increased $64 million, due again primarily to the U.K. acquisitions.

Capital expenditures for the year-to-date period were $43.8 million, down slightly from the prior year level of $44.5 million, and we ended the year with cash and cash equivalent levels of $197.8 million.

Those are the key financial highlights for the third quarter. Let me now turn your attention to our outlook for the fourth quarter of fiscal 2010.

Total sales are expected to increase in the high teens to low twenties range for the fourth quarter. This increase in sales is driven by a mid single-digit increase effect at our retail segments and a low-teens increase effect at our corporate apparel business. On a comparable store sales basis, Men's Wearhouse is expected to increase in the mid to high single-digit range, and K&G as well as Moore's to increase in a low single-digit range. Included in this comparable store sales outlook is a low double-digit increase in tuxedo rental revenue.

Total gross profit for the fourth quarter is expected to increase in the high teens to low twenties digit range from the prior year levels. This increase in gross profit is driven by the effect of a retail segment in the high single digit to low double-digit range, and from our corporate apparel business in the high single-digit range.

Excluding non-cash impairment charges as well as acquisition-related expenses, fourth quarter SG&A expenses are expected to increase in the high teens digit range over the prior year quarter level, up $184.3 million. This elevated level of expenses in the quarter is due to a number of factors. First, SG&A expenses related to the acquired U.K. operations are expected to result in a high single-digit increase.

Second, SG&A expense in the quarter related to employee medical costs from a high level of claims, and employee bonus costs due to exceeding full year financial targets, are driving an increase in SG&A in the mid single-digit range. We estimate the impact of these items to be approximately $0.10 in earnings per share. The remaining increase in SG&A in the high single-digit range is primarily due to increased marketing and payroll-related costs.

The effective tax rate benefit for the fourth quarter is expected to be 41% compared to last year's fourth quarter rate of 45.55%. The higher tax rate in last year's quarter is primarily due to a true-up of our annual tax provision as a result of the non-cash impairment charge taken in last year's fourth quarter. We estimate the impact on the prior year's diluted earnings per share from this prior year true-up to be a benefit of $0.04 per share.

In last year's fourth quarter, the company reported a revised $0.36 loss per share. That result included a $0.25 asset impairment charge and the just-discussed effective tax rate benefit of $0.04. Adjusting for these items, last year's fourth quarter was a $0.15 loss per share.

In this year's fourth quarter, the company expects a $0.22 to $0.2a5 loss per share on a GAAP basis. That expectation includes a $0.03 charge for acquisition-related expenses and the costs associated with the cessation of tuxedo distribution activities and four distribution centers.

Adjusting for these items, and the impact of the higher medical costs and employee bonuses discussed earlier, this year's fourth quarter will be a loss of $0.09 to $0.12 per share compared to the prior year adjusted loss per share of $0.15.

That concludes my prepared remarks on the numbers for the quarter. I'll now turn the call over to Doug Ewert, president and chief operating officer. Doug?

Doug Ewert

Thanks Neill, and good afternoon everyone. As Neill mentioned, our tuxedo rental volume increased 13.9% in the third quarter, ahead of our initial expectations as well as sequential improvement from the 10% increase in the second quarter.

As we look to the fourth quarter, we're expecting a high single-digit rate of growth, which is the result of entering the seasonal low period for the tuxedo rental business. As in the second quarter, growth in tuxedo revenue was the result of aggressive marketing efforts, close collaboration with David's Bridal, and the positive word of mouth that comes from servicing over a quarter of a million wedding parties a year. As discussed on previous calls, our ongoing efforts to further rationalize our network of tuxedo stores and distribution centers are on track and delivering the anticipated results.

I will now turn your attention to our big and tall business. As a company, we have over a $300 million big and tall business, which is increasing at a 40% faster rate of growth year-to-date than that of our regular product categories. We are not new to big and tall, and have built this business over the last three decades. We believe we have a strong brand among big and tall customers. To further expand our market share and better serve this growing segment of the population, we have decided to test three freestanding big and tall stores under the Men's Wearhouse brand next year. We will keep you posted on the results of this test as appropriate.

At K&G, we reported to you on our last quarterly earnings conference call we would be focusing our efforts on improving the profit profile of this business by 1) closing unprofitable stores, a total of six this year, 2) focusing on our core customer, with targeted price promotions, and 3) launching a new K&G website that is e-commerce capable, which leverages off of our web platform currently deployed in support of our Men's Wearhouse site.

Our focus on our core customer is delivering positive results. For example, our urban men's suit business is trending up 200% season to date. Our experience concerning a more targeted price promotion strategy for K&G has yielded mixed results, and we will continue to refine our strategy to deliver results that improve both the top line and the bottom line. Our new e-commerce-enabled website will launch early next year.

On August 6, we completed the acquisition of Dimensions and certain assets of Alexandra for $97.8 million, expanding our presence in the corporate apparel and workwear industry. Our sales results for the third quarter were at the high end of our initial plans, and we exceeded our initial earnings per share estimates. In early November, we received official clearance from the U.K. Office of Fair Trading of those acquisitions. Under the strong and experienced leadership of Simon Hughes, we are moving aggressively to build on our market-leading presence in the corporate apparel business in the U.K.

Finally, I want to share our current thinking as it relates to the issue of product cost increases. We are experiencing cost increases for the third quarter of 2011 deliveries in the low single-digit to low double-digit range on select product categories. We have a few levers to help mitigate the impact on our margins, including shifting the balance between designer brand and private branded businesses, countersourcing with alternative mills and factories, consolidating our suppliers, and by selectively raising our retail prices.

It's our strategy to pull on each of those levers in moderation. I would also add that the growth of our big and tall business will help, in that big and tall delivers a higher margin than core business. It is our current belief that our strategies will result in very little if any margin erosion next year attributable to product cost increases.

On behalf of the 17,000 hardworking men and women whom we work for, I want to thank you for your interest in our company, and express my enthusiasm and confidence in our near- and long-term potential.

We will now open the call to your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session. [Operator Instructions.] Our first question comes from the line of Brian Tunick, with JP Morgan. Please go ahead.

Ike – JP Morgan

Hi guys. It's actually Ike, calling in for Brian. Wanted to talk about the gross margin line in Q3. Giving up about 400 basis points of product margin and in return getting about 500 basis points of leverage on expenses and occupancy, can you kind of talk us through how you look at the business model now in terms of how much margin you're willing to give up in order to drive top line sales?

Doug Ewert

We're trying to drive profit dollars, and that's how we're looking at each one of these promotional events. We generally experience a significant lift in volume during these events. There is a short payback period afterwards, and then we look at the total accretion from the event. And so we have been very pleased with the results, obviously sacrificing some margin percent in exchange for dollars.

Ike – JP Morgan

Okay, and then just a real quick followup. For Q4 on the SG&A, how do you guys accrue bonuses, and did you take a bonus last year? Just trying to connect some of the dots there.

Neill Davis

We accrue our bonuses a portion in the second quarter of the year, a portion in the third, but the lion's share in the fourth quarter of each year, and last year we did not meet our financial targets and paid minimal bonuses. This year, clearly, with results that you've heard us report through the first three quarters and what we've outlined for the fourth quarter, we'll be exceeding our planned targets for the year to result in incurring greater dollars as a whole.

Operator

And our next question comes from the line of Janet Kloppenburg with JJK Research. Please go ahead.

Janet Kloppenburg – JJK Research

I just had a couple of questions, first of all on the marketing expenses. I'm hearing that they're going up, but I thought, George, that when you had resorted to this more promotional strategy you talked about marketing costs coming in and you highlighted that they would be down for next year. So I was wondering why they'll be up in the fourth quarter. That's my first question.

George Zimmer

Well, the plan that we've been operating on, and that we've decided to stay with, called for higher marketing spend in the fourth quarter. We looked at whether or not we wanted to make an adjustment, decided against it, and decided to make it next year.

Janet Kloppenburg – JJK Research

And is that just from Men's Wearhouse, or is there higher costs for K&G and Moore's as well?

George Zimmer

Yeah, they all had a little higher costs, and a lot of it was production related, which is where half the savings will come from.

Janet Kloppenburg – JJK Research

Okay. And then given how well Moore's did in the third quarter, I was wondering why you had more cautious guidance on their comps for the fourth quarter. I mean, if marketing's going to be up, and the promotional strategy is going to be as it is, is there something I'm missing there?

Doug Ewert

We're not able to operate Moore's with as aggressive a promotional posture as we can Men's, just because of the environment in Canada. And so the results aren't as significant in Canada from a more promotional posture.

Operator

Our next question comes from the line of David Mann with Johnson Rice. Please go ahead.

David Mann – Johnson Rice

If I could go back to the gross margin question, it looks like your clothing product sales were up $70 million in the quarter, but the clothing product gross profit was only up a couple million. Is that all because of the hit by being more promotional, or is there something else going on there? And if it is because of being more promotional, is that the way it's going to be going forward?

Neill Davis

It just depends on - again, the balance as we pursue these promotions, as we've walked into a more aggressive posture in the back half of the year, is to drive incremental growth in the gross profit dollars. I wouldn't take necessarily the results in the third quarter as being indicative of what's going to happen on a go-forward basis.

Doug Ewert

We're also learning as we go into each one of these promotional events, on which handles work stronger than others, and so we are gaining some pretty strong learning as we go through this.

David Mann – Johnson Rice

Okay. And then if I could follow up. In terms of the comp guidance that you gave for the fourth quarter for Men's Wearhouse, that looks to be a sequential slowdown on a two and a three year basis. Can you just comment on how you thought the November promotion went, and whether you are building in some sort of effect on the January event?

George Zimmer

The November event was fantastic, and we had the single largest day in the history of our company on Black Friday. I think that I need to say that we're extremely satisfied with these results, and we understand that Wall Street is less satisfied. But this is a different business reality, where we do not have the certainty that we had several years ago. So as we report and discuss these results, although we may not have as close a handle as we used to, we're very happy about these results.

Operator

And Ms. Janet Kloppenburg, please continue with your question. We apologize for cutting you off.

Janet Kloppenburg – JJK Research

Oh, that's okay. I'll try and ask my two questions at the same time. I guess maybe it relates to what George just said, but the comps at Moore's I think were up close to 6% in the third quarter, and you're only looking for them to be up again low to single digits and last year you had a minus 6.6, so I was wondering if there was something - is that just the uncertainty that you're dealing with, George, and you don't know maybe if November and December could take from January? I appreciate that, but I'd love to learn more. And then, also on the costs, I think you're looking for a loss of $0.19 to $0.22, but you want us to think about it as a loss of $0.09 to $0.12, except I'm not sure that next year the bonus level won't be as high. So I don't know why we would take that out? Do you understand what I'm asking Neill? Why is it an exclusion? If it's going to be built into your business model, I'm not sure why I should be excluding it?

Neill Davis

Well, when you're comparing the results on a quarter-over-quarter basis, I think it would be appropriate for you to be aware of the impact to the expense numbers. I believe you're correct and when you look out to next year depending on what our planning is, what our numbers are, the number should be similar if in fact we do achieve our sales targets. We did not do that, in fact, last year. So when you look at it on just a discrete quarter-over-quarter basis, there are anomalies and it relates to our methodologies as to how we pay our bonus comp. But if you step back and look at our business on a full year basis, I think the EPS number is somewhere around $1.48, which is a significant increase over last year. So we just call that out for you to take that into consideration in evaluating the business on a quarter to quarter basis.

Janet Kloppenburg – JJK Research

The $1.48 is considering the loss as $0.19 to $0.22? Or $0.09 to $0.12?

Neill Davis

$0.19 to $0.22.

Janet Kloppenburg – JJK Research

That's what I thought. And then my question on the comps. Are you just worried about what's going to happen in January?

George Zimmer

I don't think it's a worry as much as an honest inability to predict as accurately as we used to.

Janet Kloppenburg – JJK Research

I don't mean to push on it, George, but I saw your Black Friday ads for Men's Wearhouse, and the one you're currently running now, which is something like 40-50-60% off, depending on what you buy. I don't know what it is at Moore's, but are you pulling in your advertising at Moore's right now? Or is the momentum the same?

George Zimmer

Well, Doug tried to indicate that it's not as good as Men's Wearhouse, but still positive momentum. So there's a different retail regulatory situation in Canada, and so we have to be much more conservative in our promotional stance.

Operator

Thank you. And our next question comes from the line of John Kiernan with Cowen & Company. Please go ahead.

John Kiernan – Cowen & Company

Can you talk about the seasonality, if there is any, in the corporate apparel business, why it's going from $0.03 accretive in Q3 to neutral in Q4?

Neill Davis

The reason for the delta has less to do with the seasonality of the business, more to a higher gross margin as it relates to the Alexandra component of the business than what we had anticipated it to be. So it is more of a forecasting dynamic as opposed to a seasonality dynamic.

John Kiernan – Cowen & Company

Okay. And then I got disconnected for a bit. Did you quantify the $0.10 in Q4 due to higher bonus and higher benefits - how much is from bonus and how much is from benefits? Is it even, or -

Neill Davis

I didn't, but I will tell you that the bonus is about 60% of it.

John Kiernan – Cowen & Company

Okay. And just one more. Do the increased comps change your plans next year in terms of store closures in the Men's Wearhouse segment? Are you seeing improvement the past couple quarters? [Do the] store closures change next year in that segment?

George Zimmer

Let's be clear, to begin with, that we're not closing regular Men's Wearhouse stores. We're closing acquired Men's Wearhouse and Tux stores.

John Kiernan – Cowen & Company

I'm sorry, that's what I meant.

George Zimmer

Right. Well, we're not significantly modifying it, but we always remain open that business will get better, and many of these stores were right on the border, and so there is the chance that a store could do enough increased performance to remain open. But on a large picture view, we don't think it would be significant.

Operator

[Operator Instructions.] And management, I show no further questions in queue at this time. Please continue.

George Zimmer

All right. Well, all we have to say is from everybody at the Men's Wearhouse, Merry Christmas!

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