Neiman Marcus Group F1Q08 (Qtr End 10/27/07) Earnings Call Transcript

Dec. 5.07 | About: Neiman Marcus (NMG)

The Neiman Marcus Group, Inc.

F1Q08 Earnings Call

December 5, 2007 11:00 am ET

Executives

Stacie Shirley - Vice President, Finance

Burton M. Tansky - President and Chief Executive Officer

James E. Skinner - Executive Vice President, Chief FinancialOfficer

Analysts

Karru Martinson - Deutsche Bank

Emily Shanks - Lehman Brothers

Carla Casella - J.P. Morgan

Grant Jordan - Wachovia

Dana Cohen - Banc of America Securities

Jeff Kobylarz - Stone Harbor Investments

Ryan Blume - Hartford

Operator

Good day, ladies and gentlemen, and welcome to the firstquarter 2008 Neiman Marcus Inc. conference call. (Operator Instructions) Iwould like to turn the presentation over to your host for today’s call, Ms.Stacie Shirley, Vice President, Finance. Please proceed.

Stacie Shirley

Thank you. Good morning, everyone and thank you for joiningus. Joining me on the call today is Jim Skinner, our CFO; and Burt Tansky,President and CEO of Neiman Marcus.

Before I pass the call to Burt, we have our normalhousekeeping items to review. The call today involves our view of the futurefor the businesses that make up Neiman Marcus. Any statements referring to theexpected future plans and performance of Neiman Marcus are forward-lookingstatements and actual future results may differ materially from suchstatements.

Please refer to our SEC filings where we include adescription of the factors and risks that might cause our future results todiffer from what we will be discussing today. Unless noted otherwise, allreferences to operating earnings exclude the impact of purchase accountingadjustments related to the acquisition of the company in October 2005.

In addition, unless noted otherwise, all statements reflectthe sale of Kate Spade and the financial statements have been restated andtreated as discontinued operations. For more details, please refer to our 10-Q,which we filed this morning.

And with that, I will turn the call over to Burt.

Burton M. Tansky

Good morning and thank you for joining us today to reviewour first quarter results. This was another good quarter for us as we onceagain achieved record sales and operating earnings. Let me begin byhighlighting a few of our achievements.

Sales continue to be strong with an increase in total salesof almost 9% and comparable revenues increased 6.5% for the quarter. This is ontop of a 6.8% comp sales increase last year.

Our sales per square foot reached a new high of $647 for thelast 12 months compared to $613 a year ago. This is an increase of almost 6%.We continue to hold an industry-leading position in terms of productivity.

We’ve achieved this improvement in productivity while stillopening new stores which can be less productive in the first few years ofoperation and therefore a drag on overall sales per square foot.

Having said that, the environment has proven to be somewhatchallenging this season and we have experienced a year-over-year decline in ourgross margin rate for the quarter. Last spring we made a decision to buy thefall season at a higher rate of increase than we have in the past few seasons.

As the season progressed and sales did not materializecommensurate with the inventory levels we had planned, our merchants reactedquickly, working with our vendor partners to find a solution to our overstockposition. Additionally, in an effort to bring our inventory levels in line withdemand, we incurred higher markdowns.

However, despite these challenges, we still achieved anadjusted operating margin of 15.5% for the quarter and we achieved a firstquarter record operating income of $175 million, which is a 4% increase overlast year.

Now let’s review our specialty retail stores division, whichincludes Neiman Marcus stores and Bergdorf Goodman. Sales at Neiman Marcusstores increased 5.4% on a comparable basis and sales at New York City atBergdorf Goodman were a very robust 11.6%. That’s over a strong 10.3% increaselast year.

Supporting these results were favorable sales trends in thefollowing categories: designer handbags, shoes, couture, beauty, jewelry,primarily our higher end precious jewelry, and men’s furnishings.

We continue to work diligently on a number of initiatives atour specialty stores division that we discussed last quarter. These initiativesare centered around merchandise assortment, customer interaction, and logisticsplanning for our ongoing growth. Although the initiatives have not changed, wecontinue to take active steps in implementing these initiatives into ouroverall strategy. I will update you in the future as we progress.

And now an update on our real estate activities; as you knowmay know, our most recent store opening was a 100,000 square foot store inNatick, Massachusetts, a suburb of Boston. The store is beautiful with a veryunique exterior finish that has received very positive reviews.

As to future openings, our plans remain unchanged from whatwe discussed last quarter. We have publicly announced five additional locationsthat will open in the next four fiscal years. In addition to full line stores,we opened a last call clearance center in Philadelphia, Pennsylvania this pastNovember.

As for remodels, we continue with a major renovation at ourAtlanta store, where we have completely redone the store and addedapproximately 50,000 square feet. Even with the disruption caused by theremodel, business has remained strong. We expect to finish construction byearly fiscal 2009.

Obviously, the store environment is critical to thatexperience so that we are highly motivated to invest continuously in our storesto ensure that we are adding excitement to the store environment and alwaysexceeding our customers’ expectations.

To that end, we have also focused on several minor remodelsthis year. Often a major remodel includes adding square footage and touchingalmost all areas of the store. A minor remodel is more focused on certainaspects of the store. While the investment is significantly less than a majorremodel, the impact can be very meaningful.

In addition, we have many selling projects that will furtherenhance our stores, resulting in higher sales volume and greater productivity.As an example, selling projects include vendor shops, merchandise reallocation,and a repositioning of a department.

Lastly, at Bergdorf Goodman, we continue our capitalinvestment. In fiscal 2008, we have planned several projects, includingremodeling part of the main floor in the jewelry area, redoing part of themen’s store, and building several vendor shops.

Now a few comments on our direct marketing segment, whichincludes the Neiman Marcus, Bergdorf Goodman, and Horchow brands. Sales for thequarter were $171 million, an increase of approximately 7.1%, over a strong14.7% increase last year. Leveraging this sales increase, we achieved a recordoperating margin for the quarter of 13.6%, a 50 basis point improvement overlast year.

Overall, our fashion business was very strong this quarter. Morespecifically, the strongest categories in the direct division included Jewelry,women’s apparel, designer shoes, handbags, and men’s furnishings.

Our Internet sales continued to grow at a much faster pacethan overall company growth. Internet sales for the quarter were $124 million,an increase of almost 23% over last year. All of our Internet businessescontributed to this growth.

As expected, catalog sales declined. We continue to reduceour circulation to recognize the shifting of revenues to online and we expectthis trend to be ongoing. In addition, the home area, primarily under theHorchow brand, continues to be challenging. It is apparent from the results ofbusinesses in the home improvement and home building sectors that the home areais difficult right now and our business is no exception.

In order to continue our strong growth at direct, we havemany initiatives in place. Today I’ll provide a high level update of theseinitiatives.

We continue to explore new and innovative marketing techniques,including virtual trunk shows and enhanced tools on the site to increase theinteraction with our customers. Our goal is to reach our customers in uniqueways, to keep them excited about visiting and more importantly, shopping on oursite.

In addition, in fiscal 2008 we will continue to invest asignificant amount of capital and technology to support this business. Theseinitiatives will enhance our systems to allow us to more efficiently andproactively manage our various businesses.

The projects include the continual rollout of merchandisereports, which will enable our merchants to better understand the nuances oftheir business; completing deployment of an item workflow management systemthat will reduce the labor hours involved in setting up new products and willallow for greater flexibility in our buying decisions; and lastly, upgradingour systems platform to increase customer personalization and enhancenavigation and search capabilities.

On a final note, I am pleased to announce some recentinternal promotions. Karen Katz, President and Chief Executive Officer of theNeiman Marcus stores, has been promoted to an Executive Officer of the NeimanMarcus Group, with additional responsibilities for strategy, businessdevelopment, and marketing.

Also, Jim Skinner, Senior Vice President and Chief FinancialOfficer of The Neiman Marcus Group, has been promoted to Executive VicePresident and Chief Financial Officer of The Neiman Marcus Group and assumesthe additional responsibility for information systems.

Jim and Karen will continue to report to me and will becomepart of the Office of the Chairman. The Office of the Chairman will beresponsible for leading the overall strategic direction of the company andsetting policy. Karen and Jim have demonstrated outstanding leadershipcapabilities, exceptional performance, and an unrelenting focus on performanceand these promotions will provide them with development opportunities that willhelp them prepare for broader responsibilities as we grow.

In closing, let me reiterate -- we are pleased with ourresults. This was a quarter of great reflection for our company as wecelebrated our 100th anniversary. We realize not many retailers reach thismilestone and we don’t take it lightly. We achieved this accomplishment throughthe strength of our associates, our vendor partners, and our customers and welook forward to the next hundred years.

But right now, we are focused on the holiday season. Weannounced our November sales results this morning. Total comparable revenuesincreased 5.8% for the month of November. Comparable revenues in the specialtyretail segment increased 6.1% while Neiman Direct comparable revenues were up4.3%. We believe this is a good start to the season and as always, we willstrive to successfully balance our long-term strategy of customer service,merchandise and fashion leadership with continuing to improve the productivityand profitability of our operating model.

Thank you, and now Jim will review the financials.

James E. Skinner

Thanks, Burt. First, I will begin with our consolidatedresults. Let’s begin with sales. As Burt mentioned, we experienced strongtrends reaching $1.13 billion in the first quarter of ’08, an increase ofalmost 9% from last year. Comparable revenue for the first quarter increased6.4% for the specialty retail store segment and 7.1% for our direct marketingsegment.

For the quarter, gross margin decreased approximately 50basis points compared to last year. This decrease was primarily due to highermarkdowns and a lower level of full price sales at our specialty retail storesduring the quarter, partially offset by the leveraging of our buying occupancycosts.

As Burt mentioned, we conducted additional promotions in thefirst quarter to reduce inventory levels. In the second quarter, we also expectto incur a year-over-year increase in markdowns in our specialty retail storesas we will continue additional promotional efforts to complete the sell-throughof the fall season’s inventory.

We also experienced decreased margin at our direct marketingsegment, primarily due to the higher usage of free shipping promotions comparedto last year. We do expect our usage of free shipping and other promotionalactivities will continue through the second quarter.

Based on the additional markdowns and the continued usage offree shipping, we currently expect our second quarter gross margin rate will belower than last year.

For the first quarter, our SG&A rate increased about 20basis points. This increase was primarily due to a higher level of advertisingand promotional cost of approximately 50 basis points incurred by our specialtyretail store segment in connection with first, the celebration of our 100thanniversary in October, 2007, and also promotional events and activitiesconducted to facilitate the sell-through of inventory.

Partially offsetting this increase was a decrease inmarketing and advertising costs incurred by our direct marketing segment ofapproximately 20 basis points, primarily due to the continued planned shiftfrom catalog to web-based marketing. Web marketing costs are generally lower asa percent of revenue than print catalog.

In addition, we leverage the fixed component of SG&Aexpenses over a higher revenue base.

In total, adjusted operating earnings, which excludescertain non-recurring items as detailed in our earnings release, increasedapproximately 4% in the first quarter compared to last year.

On a rate basis, adjusted operating earnings declined to15.5% of revenue, compared to 16.2% a year ago, primarily the result of thefactors I mentioned earlier, including higher markdowns and a decrease in fullprice selling at our specialty retail stores, along with an increasedadvertising and promotional cost incurred by our specialty retail stores.

Now a brief for you of our segments; specialty retail salesincreased 9.3% for the quarter and on a comparable basis, sales increased 6.4%.Sales at the specialty retail stores division benefit from the success of ournew stores and major remodels and ongoing positive impact of the initiativesthat Burt discussed.

Operating earnings at the specialty retail division were$166 million this quarter compared to $157 million in the prior year, an almost6% increase. On a rate basis, specialty retail stores operating margin was17.2% compared to 17.8% for the prior year fiscal period.

This decrease is due to the factors mentioned earlier,including higher markdowns on lower level of full-price selling, along with ahigher SG&A expense as a percentage of revenue driven by higher advertisingand promotion expenses.

At Neiman Marcus Direct, the Internet again drove the salesof the division with Internet sales growing approximately 23%. We again hadimprovement in several key e-commerce metrics, including total number ofcustomers, average order value, gross demand, and number of orders, and weincreased our conversion rate, which as many of you know is an extremelyimportant direct-to-consumer business.

We also did an excellent job of leveraging our operations.Quarterly operating earnings at Neiman Marcus Direct increased almost 12% to$23 million, which represents a record operating margin for the first quarterof 13.6%, an increase of over 50 basis points from last year.

The increase in operating margin is primarily the result ofa decrease in marketing and advertising costs, as we discussed, as a percent ofsales, as business continues to shift to the Internet, that was partiallyoffset by a decrease in margin realized on delivery and processing revenues.

In September 2007, our board of directors approved certainchanges to our long-term benefit program. In connection with the redesign ofthis program, we recorded a one-time, non-cash pension curtailment gain of $32million in the first quarter of fiscal 2008 to reflect the impact of freezingbenefits to be provided by our pension retirement plan as of December 31, 2007.

We made this change after a careful review of our currentprogram and analysis of benchmarking data for retirement programs in ourindustry. The new plan continues our longstanding commitment to providecompetitive retirement benefits but also reflects changes in the way ourassociates work and plan for retirement.

Also for the first quarter, we incurred approximately $61million of net interest expense compared to $69 million last year. The decreaseis primarily due to the repricing of our term loan as well as the pay down of$250 million of debt during fiscal 2007.

Our effective interest tax rate for the quarter was 38.7%and we expect our rate going forward will be approximately 39.1% -- income taxrate, right.

Now just a few comments on the balance sheet; inventoryincreased about 11.8% to $1.09 billion, which is above our sales improvement.We eliminate the -- if we eliminate the inventory for the two new stores weopened and the new clearance centers, inventory increases are approximately8.1%, which is slightly below our sales improvements.

As Burt mentioned, we reported a 5.8% comp for November.Keep in mind most retailers had a 53rd week in their last fiscal year, whichcreates a timing shift in the current year. We will not have our 53rd week yearuntil the end of this fiscal year; therefore, we don’t have the comparableissues that most retailers are experiencing this year.

With that, I’ll thank you and turn it over to Stacie.

Stacie Shirley

Thank you. We ended the first quarter with cash of $81million, compared to $159 million a year ago. The $159 million included theproceeds from the sale of Laura Mercierof approximately $41 million. We held back cash until the second quarter offiscal 2007 when we made a payment on the term loan.

Capital expenditures for the quarter on a gross basis were$46 million and we received developer contributions of $12 million, resultingin net CapEx of $34 million. The majority of the CapEx this quarter was spenton new stores and major remodels.

For fiscal 2008, we expect capital expenditures on a grossbasis to be in the range of $200 million to $210 million and on a net basis,approximately $165 million to $175 million. As in the past, the majority of ourplanned capital spend will be investments in new stores, remodeling of ourexisting stores, and in technology.

Our adjusted EBITDA for the first quarter of 2008 was $210million, which represents an improvement of 2.4% from last year. Excluded fromthe Q108 adjusted EBITDA result is the $32 million non-cash pension curtailmentgain that Jim mentioned and as detailed in our earnings release.

The combination of utilizing our excess cash flow to paydown the term loan and the continued strong EBITDA performance has resulted ina leverage ratio of approximately 4.3 as of the end of the first quarter. Whenwe adjust the calculation to reflect the definition per the debt documents, ourleverage ratio is lower at about 4.1. This compares to a leverage ratio of inexcess of 6 times at the time of the acquisition.

And lastly, we estimate the general basket for restrictedpayments to be in the range of $360 million to $380 million as of the end offirst quarter and as we’ve discussed in the past, it’s a very detailedcalculation so until the point in time when we anticipate using the basket,we’ll continue to just estimate the size of it.

And with that, we’d like to turn the call over to theoperator and we’ll take your questions.

Question-and-AnswerSession

Operator

(Operator Instructions) The first question comes from theline of Karru Martinson from Deutsche Bank. Please proceed.

Karru Martinson -Deutsche Bank

Good morning. If we could drill down a little bit more onsome of the outlook for gross margins; with inventory up, a much morepromotional environment, should we expect a similar or greater contraction ingross margins here as we go forward?

James E. Skinner

Well, as you may know, we don’t provide forward-looking guidanceso other than to say that our gross margins will be down compared to last year,that will be the only guidance that we’ll provide.

Karru Martinson -Deutsche Bank

Okay. In terms of your aspirational customers, what are youseeing there on that side of the market?

Burton M. Tansky

Well, we’re seeing a continual interest in the qualitymerchandise that we sell and we’re still selling it -- the best of ourmerchandise continues to sell very well. It’s hard for us to focus in on theaspirational customer because we don’t know them nearly as well as we do ourfull-time loyal customer.

However, I will tell you this, that we’re getting goodselling across most categories and at a variety of price ranges, starting fromwhat we call opening price to the top, so my assumption is that theaspirational customer is still very much in the stores and shopping.

Karru Martinson -Deutsche Bank

Okay, and I guess in that same vein, what are you seeing atyour more experimental, the custom stores?

Burton M. Tansky

Well, as you know, the Cusp stores, we have four of them,one of which in Northbrook, which is a suburb of Chicago, opened quiterecently. And all four of them are doing quite well. We are constantly tryingto understand more and more about the business, fine-tuning the assortments andwe’re very pleased with the results that we’ve gotten so far.

Karru Martinson -Deutsche Bank

And just lastly, in terms of the home category, perhapscould you drill down a little bit more in terms of the plans to improve thatside of the business? Some other retailers have talked about some early signsof traction on that and I was wondering what your outlook was there.

Burton M. Tansky

Well, our outlook is probably very similar to what theindustry is going through. Our sense is that home remodeling has subsidedsomewhat. New house building we know is down substantially and I thinkgenerally, the customer is waiting it out to make the kind of home improvementsthat would include purchases of our kind of product, which includes furniture,which is a big part of our business.

We continue to sell furniture and we continue to sell acrossall the accessory lines. It’s just that we’re not selling at the levels that wehave been. We’re not going to change our strategy. We’re not going to get morepromotional than we are. We’re not going to start discounting.

What we’re going to do is continue to offer the customer afine product, an assortment of products as we always have and get through thisperiod.

Karru Martinson -Deutsche Bank

Thank you very much.

Operator

The next question comes from the line of Emily Shanks fromLehman Brothers. Please proceed.

Emily Shanks - LehmanBrothers

Good morning. I wanted to see if you could help usunderstand what the ad spend was specific just to the 100th anniversary -- canyou break that out for us?

Stacie Shirley

What the spend was for the 100?

James E. Skinner

You were breaking up. We had a little trouble hearing yourquestion.

Burton M. Tansky

Yeah, say it again, would you, please?

Emily Shanks - LehmanBrothers

Apologies. Can you hear me okay? Okay, thank you. We knowthat you noted that SG&A deteriorated as a result of spend on both the100th year anniversary as well as just overall potentially increasedpromotional spend. But I wanted to see, could you let us know what the actualbreakout was just for the 100th year anniversary?

James E. Skinner

In round terms, if you look at the 50 basis points decreasein SG&A, probably half of it relates to the 100th anniversary.

Emily Shanks - LehmanBrothers

Okay, perfect. Thank you. And then on the question aroundCusp, thank you for the details on it. I just wanted to see -- would youcategorize that customer, and I recognize it’s early on in its life, but wouldyou categorize that customer as more aspirational than the customer visitingthe Neiman Marcus stores?

Burton M. Tansky

Well, I think if you looked at overall, generally I wouldsay yes; however, what we are finding is that we are finding some customers,probably more than we anticipated, that could straddle both Neiman’s and Cuspand are far from aspirational, or are affluent and are coming in and buying atthe Cusp store because they like the assortments and they like what they seeand that, of course, has resulted in our selling at the top of the price range.

But I would say that in a broad sense, that the customer isprobably more aspirational certainly than the Neiman Marcus stores experienced.

James E. Skinner

In some ways, you’d almost view that [cyclographical] versusdemographical though, because it tends to be a younger age group, that tends tobe less wealth.

Emily Shanks - LehmanBrothers

Okay, that’s very helpful. And then just one last question;in terms of the new store openings for ’08, are we still on track to see L.A.in the fall and then Seattle in the fall of ’09?

Burton M. Tansky

Yes, we’re on track. No change.

Emily Shanks - LehmanBrothers

Okay. Thank you.

Operator

The next question comes from the line of Gretchen [Halye]from J.P. Morgan. Please proceed.

Carla Casella - J.P.Morgan

It’s actually Carla Casella from J.P. Morgan. I’m wonderingif on the cost side, are you still seeing -- I’m sure you’re still seeinginflation on the cost of your goods. Are you passing -- how much of that wouldyou say you are passing on through your pricing?

Burton M. Tansky

Yes, we’re seeing inflation, of course, with the dollarcontinuing to weaken. We pass it on 100%.

Carla Casella - J.P.Morgan

Okay, and there’s no problem there?

Burton M. Tansky

We pass along the inflation to our customer.

Carla Casella - J.P.Morgan

Okay.

James E. Skinner

That doesn’t mean that the vendors aren’t working to mutethat inflation.

Burton M. Tansky

Yeah, the vendors are doing what they can and have probablybuffered some of it. It is hard to tell because we don’t know what their costbasis is. However, whatever declines in the dollar, we pass along.

Carla Casella - J.P.Morgan

Okay. And is there any way to know approximately how much ofyour revenues are tourist driven?

Burton M. Tansky

It’s very difficult. We don’t do surveys or exit surveys. Wedon’t do counts and the credit card doesn’t tell us enough information becausemany of them work off of -- at Bergdorf especially off the Visa, MasterCard orAmerican Express, so it’s hard to track that.

We just have a sense -- you know, this is all kind ofintuitive -- a sense that a chunk of the traffic in New York clearly is fromthroughout the world and especially from Europe, where it’s quite advantageousto fly over here to shop if you’re a citizen of Britain or anywhere in Europe,actually.

If you walk the streets of New York, which I know you mustdo, you hear every language conceivable and we think a lot of those people findtheir way into Bergdorf.

Carla Casella - J.P.Morgan

Yes, we’re very busy with tourists here.

Burton M. Tansky

We see some of them we think in Las Vegas. We see some ofthem in our Beverly Hills store. We see some down in Bal Harbor. From South andCentral America and Mexico, we continue to get very good business in our SanAntonio, Coral Gables, Bal Harbor stores.

Carla Casella - J.P.Morgan

Okay. And then you talked a bit about taking highermarkdowns and lower full price selling. Can you distinguish whether you areseeing any change in shopping pattern from the in-circle customer or is thispurely the aspirational that you think is the one that’s been most effective?

Burton M. Tansky

Actually, our in-circle customer is continuing to do well.It’s probably to some degree the aspirational customer.

Carla Casella - J.P.Morgan

Okay, and then in terms of new -- do you track or has thetrend changed at all in new in-circle customers? Are you seeing fewer peoplebeing added to that new in-circle list?

Burton M. Tansky

We don’t have the information sitting here but we’re addingpeople all the time. Actually, it’s a greater body than it was a year ago.

James E. Skinner

In general, if you look over the time which [is in some ofour] presentations, in-circle has grown faster than our average so again, we’renot comping negative, so if we’re comping positive, you’d expect to see morein-circle customers.

Carla Casella - J.P.Morgan

Okay. And then just one last question; on the endinginventory being up about 8%, does that mean that you did more markdowns inNovember to clear some of that or should we just expect it to stay up in thehigh single digits each quarter, excluding the unusual swings?

James E. Skinner

On the -- okay, I see. I didn’t follow quite your question.We think in more seasons, which is no big surprise to you guys, more than -- sowe’re obviously sitting here at a point in time in October. So you look at theinventory, I think you’ll see our inventories come more in line but you’ve gotto look at in total, even though you can look at it on a comp basis also.

The fact is we bought a little more aggressively this yearand we need to get back in line. We’ll probably buy more conservatively in thespring.

Burton M. Tansky

We were coming off a very strong -- as you know and ifyou’ve been tracking us, which you have been, you know that we’ve had manyyears of great success and ongoing success both on the top and bottom line. Andour trend was very strong when we started to buy this merchandise, so we were alittle more aggressive than we normally were. It didn’t come together so we aregoing to get back into balance and we’re moving quickly to do so.

Carla Casella - J.P.Morgan

Okay, great. Yep, I trust you. I’ve always successfully doneit in the past. Best of luck. Thanks.

Operator

The next question comes from the line of Grant Jordan from Wachovia. Please proceed.

Grant Jordan -Wachovia

Great. Thanks for taking the questions. Just a couple more;can you give us a little more color on if there were any categories that gotmarked down heavier than others?

Burton M. Tansky

Yeah, the one area that we’ve been a little bit disappointedin because it’s really unusual for us would be the women’s designer apparel.Some of the European collections, and I won’t name them for fear of reprisal,some of them have been very disappointing. There have been a few that continueto do very, very well but generally that area has been weak.

Grant Jordan -Wachovia

So it sounds like from some of your earlier comments theproblem in the slower sales and the resulting markdowns is more that yourcustomers had slowed down. Do you feel like product selection had anything todo with that or was is strictly that customers pulled back?

Burton M. Tansky

Well, you know, it’s hard to tell. You just don’t know.Those collections that apparently were well-received, the customers have boughtvery aggressively and price was not an issue and because they sensed that thecollections were right on target in terms of fashion, style and trend.

Those that didn’t seem to hit dead center for the customer,meaning they were correct on fashion and trend, have languished, and I think it’sjust the customer making a more thoughtful assessment of what she sees.

James E. Skinner

I was going to say one thing; you talk about slowdown andyou look at our comp in the first quarter. It was 6.5. A year ago it was 6.8.

Grant Jordan -Wachovia

Yeah, not really a slowdown.

James E. Skinner

The issue is not the demand side -- it’s the choice we madeto be more aggressive in the buy. If you buy more than demand, you have to getrid of it.

Burton M. Tansky

You know, the customer continues to demand from us qualityand we’re delivering it and none of that has changed and the best of ourmerchandise continues to sell very well.

Grant Jordan -Wachovia

And then just kind of going along with that, so you boughtthis fall last spring. Do you think you’ll see some more -- did you buy winteras aggressively as you bought fall?

Burton M. Tansky

Well, there is no winter for us. It’s fall and then itbecomes cruise/resort, the new cruise/resort merchandise is in the stores andmore is on its way, so we’re now shifting gears and cruise/resort is what youmight call either early spring or -- you know, it’s the cruise/resort season,which our customers buy into. And that merchandise has already started to sell.

So what we are doing is we are in the process of liquidatingfall and we’ve readjusted the buys where we could for cruise/resort and we’llbe, and as the spring merchandise comes in, we’ll be on -- we’ll get thatinventory managed the way it should be and the way we want it to be.

Grant Jordan -Wachovia

Okay, great. Thanks for the color.

Operator

(Operator Instructions) The next question comes from theline of Dana Cohen from Banc of America Securities. Please proceed.

Dana Cohen - Banc ofAmerica Securities

I just wanted to go back on this -- coming into thisquarter, inventories were up 16 and sales were up 9. Coming out of thisquarter, inventories are up 12, so they’ve moved in the right direction, saleswere up 9 in the last month. So would it be fair to think that the liability spreadis better going into the fourth quarter than it was -- I’m sorry, going intothe holiday season than it was going into fall?

James E. Skinner

Well, here’s what -- I think the answer -- the answer isyes, except it’s probably not for the reasons you stated. If you go back to theearnings call in September, one of the things we talked about that theinventory levels at July was a choice to bring in our goods earlier. So if youthink about it, the issue we have is not the earliness. Say that we had boughtat a lower rate but chose to bring a lot more early, in July you could havestill seen the exact same issue in July with having no impact on the fall.

So one is how much you bought and one is when you chose tobring it in. You kind of separate those issues.

That being said, if you sit there with the exposure we hadat that point in time would have been our total buy. Also, we’ve been taking alot of actions September, October, November to decrease that exposure.

Dana Cohen - Banc ofAmerica Securities

But it still would be fair to think that your fallliquidation inventory is up year over year as a component of this inventory.There’s more that needs to be marked down than there would have LY.

James E. Skinner

Yes, obviously there’s bigger markdowns in the secondquarter than the first quarter.

Burton M. Tansky

Yeah, the answer is yes but in the first quarter, for themost part through October, we don’t mark down because that’s all full-pricedselling. September is our second-biggest month and it’s the beginning of thefall season. And then as we saw that the sales were not coming commensurate tothe inventory levels, we took some very aggressive action. We started, as Isaid in my prepared remarks, we started to work with our vendors and we tookmarkdowns.

We will continue to do what is necessary to bring theinventory into line.

Dana Cohen - Banc ofAmerica Securities

Okay. And again, I apologize. I was -- I came on a fewminutes late but I think you said to a previous question that it really is someof the women’s designer. Interested in that because some others have complainedabout bridge being an issue and particularly competitive markdowns in bridge.Can you comment on some of the other categories in the store?

Burton M. Tansky

Which -- those that have not done well or those that aredoing well?

Dana Cohen - Banc ofAmerica Securities

You know, think places where you’ve seen -- one, bridge as aseparate issue because other people have commented on it, but could you justtalk about other categories that either --

Burton M. Tansky

The bridge business has been okay. You know, there’s ashifting in the bridge business now. You know, the dress business was very,very strong there and seems to have calmed down a little bit so that on a comparativeyear-to-year basis, there is some reduction in the increases. But they seem tobe hanging in.

We have some very good collections in there, in that area. Thecontemporary area is holding its own and with denim not nearly as vibrant as ithas been for the last seven years, we’re working to overcome that category andclassification and we are doing so.

So we are recognizing the issues and the changing style andtrends that the customers are demanding from us and we are making those changesand shifting. The buyers are on top of it and we believe we’ve got our armsaround most of those businesses.

Dana Cohen - Banc ofAmerica Securities

And the traditional bridge business?

Burton M. Tansky

It’s been okay. It’s got its ups and downs. I think it’sbeing impacted by the dress business.

Dana Cohen - Banc ofAmerica Securities

Okay, and then last question, just any -- and again, Iapologize if you said -- any commentary on accessory trends -- handbags, shoes,jewelry?

Burton M. Tansky

It will be very strong. Main floor is very strong.

Dana Cohen - Banc ofAmerica Securities

Okay, great. Thanks so much.

Burton M. Tansky

Handbags, jewelry, all of that is strong.

Dana Cohen - Banc ofAmerica Securities

Great. Thanks so much.

Operator

The next question comes from the line of Jeff Kobylarz fromStone Harbor Investments. Please proceed.

Jeff Kobylarz - StoneHarbor Investments

Burt, you mentioned earlier about how some of theinitiatives you have are improving merchandise assortment, customer interactionand better systems. And if you can talk about maybe customer interaction,whatever you can say how you are trying to improve that without talking to thecompetition, what can you say about what you are doing there?

James E. Skinner

As you know, our sales force is primarily a 100% commissionsales force, so if you think about owning a relationship sales force ofthousands of people, just as you have a lot of initiatives going on in themerchandise, you’ve got initiatives to go and be no different than any othersales organization, whether it’s in life insurance, private banking orcommercial, of what can I do to improve the productivity and get better tools.

A lot of the things we’re working on is from the marketingside is you look at the time that a sales associate spends either interactingin person or on the phone, and both of those communication in general isimportant to us. How do I get that person to be more efficient and moreeffective in that interaction? So a lot of time is spent on what tools do wegive them, what kind of reports do we give them to let them be more efficientin those interactions and some of the initiatives today are working on those.

Jeff Kobylarz - StoneHarbor Investments

Okay, fine. And then about the women’s designer product, yousaid it was not working out that well this past fall. Were these new designerscan you say?

Burton M. Tansky

First of all, it’s not a matter of working out well. Theyall did a lot of business but it’s an area of whether they increased theirbusiness or not. And it’s a mixed bag, a variety of both some establishedpeople and some new people.

Overall, it’s a very, very big business for us and I don’twant you to -- I don’t want to overstate the case and I don’t want you to overreact.I think that customers are just a little more selective this year and thosedesigners that they felt more comfortable with and felt that those ones thathad hit the fashion target right on the head. That doesn’t mean we didn’tbusiness in the others; it’s just that we didn’t get the increases we expected.

Jeff Kobylarz - StoneHarbor Investments

I see. Thanks very much.

Operator

The next question comes from the line of Ryan [Blume] fromHartford. Please proceed.

Ryan Blume - Hartford

I was hoping to get an update on things that you’ve learnedfrom your prior discussion in the California markets. You had cited that asbeing softer in the prior quarter and so I just wanted to see what yourstudies, what you’ve learned from your studies, if anything, at this juncture.

Burton M. Tansky

Well, the California market continues to be difficult. Weunderstand it’s an industry-wide problem and it’s hard to get our hands aroundit. We hear a lot of hearsay and we have to depend on a great deal of what ourstore managers tell us. They can’t exactly put their arms around it.

We talk about the real estate market, the sub-prime market,which is not our customer. However, the selling and building of houses bydevelopers and brokers could very well be our customers and they may be havinga difficult time.

It just seems to be a kind of state-wide issue and we don’tthink we’re the only ones going through all this, from what we can tell.

Ryan Blume - Hartford

And the other question, can you put numbers around as far asyour demo -- you know, characterizing the demographic from a gross incomebasis, if you will, for your in-circle customer versus your aspirationalcustomer, if you can put numbers around it?

James E. Skinner

In-circle, we can. Aspirational, you’re kind of talkingabout the unknown. In-circle, I think that the average is roughly -- the medianis $300,000, the mean is roughly twice that, $600,000. And they represent about50% of the sales at Neiman Marcus stores, which I’ve got a better view on thanI do at BG.

Ryan Blume - Hartford

Okay. Thank you very much. Actually, one last thing, just toget a general sense; you sound prettybullish as far as finding product that sells. I know you cited some weakness onyour women’s designer apparel but overall, are your merchandise buyers thinkingthat there is good product out there and does that -- I guess it seems to gocontrary to what the general market has said as far as the lack of innovation.So I wanted to get your sense -- are you finding that you have specific nichesthat you are able to find pockets in?

Burton M. Tansky

In our category, in our price range, the resources that weuse, there’s plenty of product and our buyers have found that product and we’redelivering the new cruise/resort merchandise right now and we’re getting very,very positive comments from the stores about that merchandise.

In fact, our buyers right now are in what we call thepre-fall buy and they are starting to buy fall merchandise and there’s plentyof goods around. That is not the problem. We just have to be more selective. Wehave to be more very, very highly focused on what we buy and continue to keepsight of the customer and see if she’s changing, slightly changing her buyingtrends.

We have experience with this. We’ve gone through it before.This customer does not trade down. She does not change venues. She does notleave us. What she does, if in fact this continues to be challenging -- we’renot sure it will be, we’re not sure at all it will be -- she’ll buy a littleless and we continue to buy the products that we know are very much what ourcustomer wants and there’s plenty of goods out there for us.

Ryan Blume - Hartford

Thank you.

Operator

The next question comes from the line of Carla Casella fromJ.P. Morgan. Please proceed.

Carla Casella - J.P.Morgan

Just one follow-up; on the pension change you made, is thatgoing to have any impact on your SG&A expenses going forward?

James E. Skinner

It might be -- the goal of this was not to go cut costs. Itwas really changing the way we fund it. This is probably going to be a minorbut not really significant enough to put in the model, if you will.

Carla Casella - J.P.Morgan

Okay, great. Thanks.

Operator

And there’s no further questions.

Stacie Shirley

Okay. Thank you. Thank you all for participating in our calltoday. You may access the replay of this call at 888-286-8010 through December19th, and the passcode is 62512458. Thank you.

Operator

This concludes your presentation for today, ladies andgentlemen. You may now disconnect. Have a wonderful week.

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