Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Saks Incorporated (NYSE:BG)

F2Q08 Earnings Call

April 24, 2008 10:00 am ET

Executives

Stephen I. Sadove – Chairman and Chief Executive Officer

Ronald L. Frasch – President and Chief Merchandising Officer

Kevin Wills – Executive Vice President and Chief Financial Officer

Julie Bentley – Senior Vice President, Investor Relations

Analysts

Dana Cohen - Banc of America Securities

Jason Trujillo - Lehman Brothers

Adrianne Shapira - Goldman Sachs

Deborah Weinswig - Citigroup

Lorraine Maikis - Merrill Lynch

Chi Lee - Morgan Stanley

Todd Slater - Lazard Capital Markets

Robert Drbul - Lehman Brothers

Michael Exstein - Credit Suisse

Operator

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

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

Stephen I. Sadove

This is Steve Sadove, Chairman and CEO of Saks Incorporated. I'm joined today by Ron Frasch, President and Chief Merchandising Officer, Kevin Wills, our CFO, and Julie Bentley, our SVP of Investor Relations.

I'd like to thank each of you for taking the time to join us. Today we'll discuss financial results for the second quarter ended August 2, 2008, 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.

Let me note that some of the comments on the call today as well as some of the information presented in our earnings release related to future results or expectations are considered forward-looking information within the definition of the federal securities laws. The forward-looking information is premised on many factors and actual consolidated results might differ materially from projected information if there are any material changes in our assumptions. For a description of the meaningful risks and assumptions related to these projections, please refer to the release and our most recent filings with the SEC, including our most recent Form 10-K.

I'll ask Kevin to briefly comment on the second quarter results and the balance sheet.

Kevin Wills

Saks recorded a net loss of $31.7 million or $0.23 per share for the second quarter. The quarter included charges related to the closing of our Saks Fifth Avenue Fort Lauderdale store of $1 million after taxes or $0.01 per share. For the prior year's second quarter, the company recorded a net loss of $24.6 million or $0.17 per share, which included after-tax charges totaling $4.3 million or $0.03 per share. Our year-to-date second quarter operating loss, excluding certain items, grew 65% to $42.7 million.

Inventories at quarter end totaled $813.1 million, up 1.4% on a total basis and up approximately 1.9% on a comparable basis.

We ended the quarter with approximately $60 million of cash on hand and no direct outstanding borrowings on our $500 million revolving credit facility. Our funded debt, which includes capitalized leases, totaled approximately $569.8 million and debt-to-capitalization was 33.4%, which was calculated without giving effect to the cash on hand.

During the quarter we repurchased approximately 1.7 million shares of common stock at an average price of $11.74, bringing the year-to-date total to 2.9 million shares at an average price of $11.83. We have approximately 32.7 million shares of remaining availability under existing repurchase authorization programs.

Stephen I. Sadove

While business became much more challenging in the second quarter, I believe our organization has responded well to the changing environment. Comp store sales for the second quarter would have been slightly positive excluding the shift of a spring season clearance event into the first quarter this year from the second quarter last year. Comp store sales for the six months of this year increased 2.7%. While substantially slower than the robust growth we had experienced over the last two years, this performance was still among the best in the industry. In addition, we made substantial progress in reducing our comp store inventory levels from the 9% increase at the beginning of the fiscal year.

During the quarter we experienced a softening across nearly all geographies and merchandise categories, although generally the better performing geographies and categories in prior quarters were still the better performing areas in the second quarter. Some of the strongest merchandise categories for Saks Fifth Avenue during the quarter included women's shoes, jewelry, accessories, and men's contemporary apparel, shoes and accessories. We experienced widespread weakness in women's apparel.

The New York City flagship store continued to outperform the company average, and the company's newly renovated stores continue to post better-than-average results.

For the quarter, the number of transactions decreased modestly, and the average dollars per transaction increased slightly over last year's second quarter.

Both Off 5th and Saks Direct posted outsized sales growth for the quarter. Direct revenues grew over 30% for the second quarter on top of last year's 40% second quarter growth as our customers continued to respond to our constantly expanding array of designers and merchandise offerings and our site enhancements. Our video elements on the site, including interviews with designers, coverage of the fashion shows and video catalogs, have all been well received by our customers.

As the quarter began we expected that we could achieve modest gross margin rate expansion, particularly since, with the previously mentioned clearance event shift, we accelerated certain markdowns in the first quarter. However, as business trends weakened during the quarter, our gross margin rate was eroded by 60 basis points. The gross margin rate was negatively impacted as sales fell below expectations and we did not achieve the expected leverage against our permanent markdowns.

Second quarter year-over-year SG&A expenses, excluding certain items, increased 140 basis points as a percent of sales. Absent the previously mentioned event shift, the second quarter SG&A deleverage have been about 50 basis points. The comp store sales decline was the principal driver of the expense deleverage during the quarter.

On a year-to-date basis, excluding certain items, SG&A increased 50 basis points as a percent of sales, with approximately 25 basis points of the increase resulting from nonrecurring transition service agreement revenue from the first quarter of 2007. The balance of the SG&A increase was principally due to strategic long-term investments in Saks Direct and other selling initiatives. Notwithstanding the year-to-date deleverage in SG&A, we remain very focused on our expense structure and will continue to balance near-term operating efficiencies with investing for the long-term.

Our 2008 strategic capital improvements are well under way and several projects are nearing completion. Our estimated capital spending plan is approximately $125 million this year, with about 70% allocated to stores and a significant portion of the balance allocated to continued technology investments associated with our merchandising and clienteling initiatives.

Our store strategy focuses our capital investments in highly productive stores and categories. By year end we will have opened or remodeled over 100 vendor shops and completed several other store projects. We are putting the finishing touches on our Naples, Florida and Boston store expansions and completing the remodel of our South Coast Plaza store in L.A., the renovation and expansion of [break in audio] core businesses in our Bal Harbour and Miami stores in Florida and in our Houston flagship are in process. These remodels primarily involve our highly productive handbag, footwear and fine jewelry areas.

We're very excited about extending certain elements from our highly successful 10022-SHOE concept in our New York flagship into other key markets. By the fourth quarter, this shoe concept will be expanded into our Beverly Hills, Houston, Phoenix, South Coast Plaza and San Francisco stores, with 10022-SHOE Beverly Hills, 10022SHOE Houston, and so on.

We're continually making investments in our New York flagship store. This year and into 2009 we will touch nearly all of its 10 floors. We're adding select vendors and expanding existing highly productive businesses throughout the store. The extensive renovation of our first floor handbag shop will be finished within the next few days, featuring, among other things, a Chanel boutique that is double the previous space. New Chanel, Guerlain, SK II and Dior cosmetic areas are all open or will be opened by next week.

Perhaps the most exciting flagship project is the complete renovation of our third floor women's designer area. This will allow us to add key designers and expand the presence of other important resources. The first phase of this renovation will be unveiled over the next few weeks with the long-awaited addition of Chanel Apparel joining other key designers in the space. The third floor project in its entirety will showcase over 35 designers and will be finished in 2009. In addition, phase one of our expanded and innovative women's Fifth Avenue Club will open in September, with completion set for January.

We're opening three new Off 5th stores this fall, all patterned after our prototype store, which opened in Orlando this spring - a store in Deer Park, Long Island will open in October, and stores in Mercedes, Texas and St. Augustine, Florida will open in November. We've announced plans to add three additional stores in 2009.

Let me ask Ron to make a few comments about our ongoing initiative for the remainder of 2008.

Ronald L. Frasch

I'd like to spend a few moments updating you on several of our key initiatives for 2008. We are committed to staying the course on our operating strategies. Our initiatives include but are not limited to increasing our selling focus, improving our assortment effectiveness, and improving our store environment and product offering through targeted capital investments and focused category development.

Our comprehensive project geared towards increasing our selling focus in the stores, which entails modifying several processes both in-store and in our support organization, remains a top priority. We continue to believe that, as we strengthen our by-store merchandise assortments, driving a full-price selling focus in the stores is a critical component to exploiting our efforts.

At the end of 2007 we finalized our pilot program and rolled it out to four stores. Armed with the learnings from the pilot, we have expanded the pilot to 16 additional stores since the beginning of '08 and expect to complete the rollout to the entire store base in 2009. We are seeing early benefits in the first wave of pilot stores as our associates seem more engaged, our product is moving through the pipeline at a faster pace, and our stores are better prepared to execute. We believe this project lends a great deal of synergy to our recent investments in our web-based clienteling system, which was tailored to enhance our customer relationship management efforts and which will be operational in our entire store base by the end of September.

We have completed the rollout of our improved assortment and allocation processes. As you recall, we implemented these process changes in our men's and accessory divisions in 2007, which represent about 40% of our volume. The men's area made their first buys under the new systems and processes for spring, 2008 and the accessories team placed their first buys this past spring for the current fall season. We completed our intended and phased rollout this past quarter as we implemented the systems and process changes in our women's readytowear zones, representing another 40% of our business.

So now with 80% of our business operating under this new paradigm we believe this will position us to drive sales and achieve gross margin expansion in the comping years. We have our first read that the improvements made in the men's area are working. We continue to gain market share in men's as evidenced by a relatively strong comp store growth in this area for the first half of the year.

On the last call I introduced our plans to reinvent our women's bridge apparel business which, industrywide, has suffered from a lack of fashion and newness for quite some time. Women's bridge, our good, remains an important element in our balanced assortments. The bridge team has spent the last several months developing our new concept for this area, including an improved product offering that appeals to the customer, focused first on fashion, then fit, then price, which is almost the opposite of what these priorities were a few years ago. Beginning this fall and into next spring you will begin to see improvements in our existing vendor structure and the addition of several exciting new vendors.

As part of the bridge reinvention is the reintroduction of our popular Real Clothes private brand. To showcase the bridge product in a fashion that exhibits the standards of Saks Fifth Avenue, we are developing a plan that focuses on an enhanced store environment. Our changes here will go beyond store design, incorporating visual presentation, merchandise adjacencies, and overall services levels. We believe that the reinvention of this business serves as one of the most significant volume and margin opportunities facing Saks Fifth Avenue. We have previously discussed our increased focus on local marketing initiatives, and we continue make progress in this area.

Before I turn it back to Steve, I'd like to take a moment to address our more near-term focus of managing our inventories. As Kevin mentioned, we entered the season with inventories up. We ended the fall season with our inventories up 1.9% on a comp basis. Considering that we entered spring with comp store inventories up 9%, we have taken the necessary and appropriate actions to reduce our inventory.

As we move forward, we will continue to aggressively manage our inventory, attempting to maintain an investment close to the level of sales. We have approached buying for fall '08 and spring '09 conservatively. We have challenged the merchant organization to make the hard decisions, to exit or reduce distribution in brands that aren't working. This is, of course, balanced with seeking out and adding new emerging designers that have great growth potential. Although a core responsibility of every merchant every day, in tough times this balancing process becomes even more critical.

Having said all that, we believe our fall fashion assortments are compelling. The wanted items, including the romantic blouse, the tailored dress, the boot, and the big bold necklace for women, and the boot made to measure for men will make key statements in our stores this fall. The season is packed full of exciting events, and the stores have truly never looked better. We are doing everything in our control to maximize sales in this challenging environment.

Stephen I. Sadove

As Ron just noted, we believe our merchandise selections are compelling, our marketing is creative, and our stores look great. And we're excited about the completion of several important store renovation projects. However, we know we are continuing to face the headwinds of the economic and retail environment. Consequently, we're approaching the near term conservatively and believe our 2008 operating margin, excluding certain items, will decline from 2007 levels.

The continuing challenging macroeconomic and retail environment makes it difficult to predict future performance with any degree of certainty. Our financial expectations for the balance of 2008 are built on the assumptions outlined in more detail in this morning's earnings release. Let me highlight a few of these assumptions.

Based on our most recent trends, we expect flat to low single digit comp store sales decline for the second half of the year. Our assumption is that the comp store sales for much of the store base will be modestly negative in the aggregate, with somewhat higher growth expected from the New York City flagship store, capital-aided Saks Fifth Avenue locations, Saks Direct and Off 5th. Keep in mind also that our comp store sales increased 11.4% in the third quarter last year and 9% in the fourth.

Comp store inventory levels are expected to be up in the low single digit range throughout the balance of the year. We're committed to managing inventories conservatively, but it's imperative that our product offering remain competitively positioned and that we maintain a new fresh flow of goods. The inventory increases will primarily be in the Saks Direct and Off 5th businesses.

We anticipate a decrease in the year-over-year gross margin rate for the fall season, the degree of which primarily depends on sales performance. Based on our markdown cadence, we expect more gross margin pressure in the fourth quarter.

We're carefully managing our expenses and we believe absolute SG&A dollars, excluding certain items, will be flat or down slightly from last year.

Everywhere you turn there's a lot of focus on the current environment and how bad everything is. We know the near term will be difficult and that we will continue to face challenges. However, we remain optimistic about the long-term outlook for the luxury channel and for Saks Fifth Avenue in particular.

Our entire team is focused on delivering and superbly executing our initiatives, many of which we've talked about today. From store process improvements to new clienteling systems to planning and allocation process enhancements to store innovations and new vendor shops to the reinvention of bridge to the continued growth of Saks Direct and Off 5th, we're staying the course with our strategies and believe we can deliver substantial revenue and operating margin expansion in the years ahead.

At this time we'd be pleased to entertain your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Dana Cohen - Banc of America Securities.

Dana Cohen - Banc of America Securities

If you look at sort of where business trends came in for the quarter versus where you thought, how much of that was traffic versus ticket decelerating versus expectations? Sort of anything. Also in terms of either categories or regions, is it fair to say that sort of everything had a step down? It's sort of the way I took your comments. The rank orders remained the same, but everything sort of moved down. Is that a fair assessment? And then also any comments on credit? I know, I mean, obviously, you don't own the card anymore but any commentary there would be great.

Stephen I. Sadove

Yes, I think that the way that you positioned it is probably correct. We saw an overall slowdown during the course of the quarter, so you could see that the July trends were weaker than the June trends. It was a situation of everything moving down, but the things that were stronger before continued to be stronger. New York continued to outpace the rest of the country. We're clearly seeing continued outsized growth in our Off 5th business. The Saks Direct business continued strong. But women's apparel, we're seeing a substantial weakness in that business. And the businesses that had performed well, like fine jewelry and shoes, continued to perform better, but their growth rate was slower than it had been.

On a geographic basis, you still saw outperformance in the markets where we had made capital investments like South Coast Plaza, Palm Beach Gardens. Those held up very well. But in aggregate you saw a bringing down of the trend. I think that you saw it primarily in traffic and traffic as opposed to ticket. You know, you saw a little bit of slowdown in ticket as well because we had been seeing more substantial increases than we saw. We were up a little bit in ticket, but we had been up higher levels prior to that.

In terms of the credit portfolio, as you mentioned, we don't own the credit portfolio. The portfolio continues to be quite good, although I would say that we saw a little bit of - continued a little bit of softening in the delinquency rate over the course of the quarter. Not at alarming levels at all but a slight uptick from where they had been.

Operator

Your next question comes from Jason Trujillo - Lehman Brothers.

Jason Trujillo - Lehman Brothers

My first question relates to the outperformance of the flagship store. What is driving that? Is it international tourism perhaps or is there something else going on?

Stephen I. Sadove

You know, I think there are a lot of factors driving the New York store. One, I think that the team has done an excellent job of merchandising that store. It's benefited from the programs like the 10022-SHOE, which has been a home run in terms of driving incremental shoe volume but also excitement and traffic to the store. So within the New York community or zip codes, we are seeing good trends.

Clearly we've seen some benefit from the tourism, international tourism. I would estimate that it's not a compelling over-large part of the growth. Probably, if you were talking, you know, in terms of percentage points, it might be somewhere between 20 and 30 percentage points of the growth, so theoretically - and I'm not giving a growth number  but theoretically, if the business were grown 10% in New York, 20% to 30% - 2 to 3 percentage points  of that growth would be coming from the incremental international tourism.

But in aggregate I think it's really driven by the compelling offerings, the innovation. If you look at all of the capital investments that have been made in that store, we feel very good about it paying off.

Jason Trujillo - Lehman Brothers

And then just looking at your overall customer base, are certain demographics or a category of customers showing greater strength? Any color on that would be really appreciated.

Stephen I. Sadove

Yes, I think in the last quarter we commented that we had seen more of a weakness from our aspirational customer and stronger trends from the Platinum, Diamond or the Saks First loyalty customer. That continues to be the case, that we've seen more weakness from the aspirational customer. I would tell you that the trends at the high end, again, while quite a bit healthier than at the aspirational customer, while good, are not as good as they were. So you're starting to see somewhat slower growth at the high end as well, but I would say that more of the weakness is being driven by the aspirational customer.

Jason Trujillo - Lehman Brothers

And then looking at the Off 5th business, I believe your last quarter you said the overlap between the Saks customer and the Off 5th customer was around 10%.

Stephen I. Sadove

Correct.

Jason Trujillo - Lehman Brothers

Has that number increased at all or any changes there?

Stephen I. Sadove

No, we don't see much in the way of change in that number. A different customer base and we continue to see very little overlap between the two. We're seeing very healthy trends in our Off 5th business, though.

Jason Trujillo - Lehman Brothers

And then just lastly, regarding the notes that are coming due at the end of this year, do you have any plans to refinance those or just to pay them off at maturity?

Kevin Wills

We will just use cash on hand and/or drawn down on the revolver to pay off those notes that come due in November.

Operator

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

Adrianne Shapira - Goldman Sachs

Can you help us understand the inventory planning? What prevents you from trying to get inventory closer to how you're planning sales in the back half?

Stephen I. Sadove

I think we are planning - first of all, we're trying to get it to be close to the sales trend. We're clearly looking at making sure that - and over time, that's where we want to be. That's the purpose of the planning and allocation work that we've done. It's the purpose of all of the investments that we made in terms of some of the inventory planning tools.

I think one of the things we've got to balance is making sure that we have the right assortments, that we edit the product appropriately. We're dealing with some substantial - we've also got to look at how many units that we're going to be having on the floor because we're looking at some substantial cost increases in some of the European goods. And remember, as we go into - some of the product that we were looking at coming into the fall we had bought six to nine months ago so that affects what inventory level we had coming into fall as well.

I don't think we anticipated - frankly, I'm hoping that we'll do better than a flat to modest decline in the fall season. I think what we're trying to do is be cautious relative to our assumptions in the current environment, but I don't think - so it's a balancing in terms of what we were looking at at the time we were buying as well as making sure that we have an appropriate presence.

I don't want us to repeat what happened five years ago or six years ago after 9/11 in terms of a panicking and running. We feel very good about the assortment, the 9-box, you know, having an appropriate profile of product in the stores, and we want to stay the course strategically.

Kevin, you want to make any comments on it?

Kevin Wills

I think that's right, Steve. And really it's just [inaudible] the lead time on inventory. If you look at our business for the spring season, second quarter was much weaker than first quarter. And I think that if you look at the JuneJuly period combined, we were down about 1.5% comp. And, you know, we made inventory commitments long before that so we're working as aggressively as we can to position ourselves as we move throughout 2008 and get our inventories more closely aligned with the sales trend.

Adrianne Shapira - Goldman Sachs

And then maybe, Steve, on SG&A, talk about the flexibility there. You know, you've made great strides in terms of shifting more to a variable cost structure in compensation. Can you give us a sense of where there is opportunity if, perhaps, you know, comps do fall short of your plan?

Stephen I. Sadove

Sure. As we've talked, about a third of our SG&A cost structure is variable, so that's going to be variable largely because we're at about 90% of volume on our associates is commission based. So you have a component that's going to be variable strictly with sales. That leaves you about two-thirds that's what we would call, quote, fixed that's going to be tied to, you know, inflation-based type of things. We're attacking all elements of our cost structure.

I think that, you know, the guidance that we've given for fall is going to be that we would be flat to slightly down in absolute dollars in SG&A. And, you know, we're looking at every line item, whether it be staffing or travel or, you know, what's the right structure that we need to run the business.

One of the things that we did over the last couple of months was to bring in AlixPartners, which is - you know, they really have focused largely in the restructuring area, but they've also been working with healthy companies to take a look at our cost base. And understand where we see opportunities, we're just in the process of working with them in terms of where we see opportunities. I think that what we're finding is there are a number of opportunities.

I'd, you know, give you one as an example. It'd be in the purchasing area, where we think that there are some further opportunities for us to - and this isn't merchandise purchasing, this would be non-merchandise area  where we think there are some opportunities.

So we do see opportunities and we're clearly tightening our belt, recognizing that, you know, it's a different environment. You know, one comment I'd make for everybody is that, you know, as tough as things are, probably I'm  the thing I'm most proud of what the organization's doing has been to turn on a dime from a double-digit growth environment to one that's a no-growth basically environment and think differently, whether it's the merchants in terms of how they're working on editing their buy to anybody in any of the support functions as well.

So I feel like we've got our hands around it. The guidance that we gave for fall I think is a good start against it, and we're going to keep pushing it.

Adrianne Shapira - Goldman Sachs

And this is my last question. On the margins, you'd talked about, you know, markdown cadence, you were expecting it to be higher in the fourth quarter. Perhaps when you look out into the back half, any sort of calendar shifts, promotional shifts like we saw in the first half?

Stephen I. Sadove

No, I think that you ought to assume that the calendar and the promotions ought to be on the same timing as it would have been last year.

Operator

Your next question comes from Deborah Weinswig - Citigroup.

Deborah Weinswig - Citigroup

On the Off 5th business, can you talk about if you're seeing kind of a greater contribution from traffic or ticket? And I know you've made some pretty substantial changes in terms of in-store. What do you think is really driving the performance there and do you think that there is kind of additional upside to come?

Stephen I. Sadove

Oh, I do think there's a substantial upside in the Off 5th business. You know, we don't really break out traffic and ticket; I think it's a combination of both that are driving the growth of that business.

It's largely driven by the change in the business model. You know right now, as opposed to being largely a sell off, leftover model, we're still running about 20% to 25% of the product is the leftovers from the Saks stores, but within the remaining, let's call it 80%, roughly 75% of that is being cut up product by the vendor community, in other words, being made for the Off 5th. In addition, the private brand assortments are much more compelling than they were in the past.

So you couple those together and you're seeing a very good response, especially - I think you're seeing a shift in the consumer towards more of what I would call our contemporary zone of business in both men's and women's is doing very well in Off 5th, more so than the classic zones, and so the customer's responding to that.

We're also, if you go to, for example, the Orlando store, where we continue to see very outsized results, we've improved the service model as well. So you're seeing a response as we've added a higher level of service. So you put it all together, you know, we've identified the new stores that are opening in the fall. The opportunities next year, I do see 5% to 10% square footage growth opportunities. And then also comp store sales as well as margin improvement opportunities in the Off 5th business.

Deborah Weinswig - Citigroup

And then Kevin had mentioned that you guys were [inaudible] some more localized marketing. Are you doing more direct to customer as well and also more online? Could you maybe just go through your marketing strategy as it stands at this point?

Stephen I. Sadove

Well, the bulk of the marketing strategy as we relate to the full line has been to move us more towards what I would call local business planning. And while we still have our national programs, it's developing the marketing plan and traffic building outreach plan by store, and we're in the process of rolling that out. And that's going to be an integral part of it. You've seen it come to life with some of - in New York, where we've done some of the outreach programs and some of the local marketing events, and we've seen very, very good response and results in the New York store to that.

You know, actually going back to an earlier question that somebody had asked about New York, I do believe that the outreach and the local marketing activities in New York have also contributed to that growth.

So I think that probably having local assortments, the 9-box and then the local marketing, is a key component of the  local marketing can be outreach, but it also can be trunk shoes. It can be local events at the store level. All of those are an important element of what we're doing.

Now Saks Direct and the marketing that we're doing against that is also being more integrated with the full line, so when we're doing the video catalogs, when we're doing the video trunk shoes, that's all an important component because we're doing the e-mail blasts and we're doing specific by-story e-mails, for example, that are being targeted coming out of the Direct business. So there's a much higher linkage between the direct marketing as well.

Operator

Your next question comes from Lorraine Maikis - Merrill Lynch.

Lorraine Maikis - Merrill Lynch

Just to touch on the remodel process for a minute, are there any stores that aren't getting a sales lift? And then second, how are you thinking about renovations over the next few years?

Stephen I. Sadove

Well, in terms of any stores that aren't getting a lift, I think the only store that - you know, right now I'm essentially seeing lift from everywhere. The store that we're probably not seeing as much of a lift would be, you know, perhaps the trends in Phoenix, where we're seeing a very difficult economic environment there. But I think that we're seeing some response, but I think it's a tough market that you're dealing with there. Our general conclusion has been that even in markets, you know, take a Beverly Hills, for example, where - the California markets, we're seeing a very good response in the areas where we did some of those renovations. So, no, you know, our net on it is that we're seeing very good responses to the capital investments.

If we look at our go forward plan, it's going to be to continue to spend, let's call it - right now it's about 70% of our total capital spend is on these renovations and we're going to continue to do that. In New York we're going to be finishing up the third floor, the designer floor, next year, and then we'll have a whole series, another set of stores where we continue to roll out the - whether it's the shoe enhancement. We've said we're doing some very major work in the cosmetic and beauty area, handbags. So these are the highly productive areas. It's also linked to several year game plans we have with major vendors relative to distribution enhancements and shop build-outs. So we feel quite good about it.

The last piece of the capital is the expansion plans. We're expanding our Palm Desert store. We're finishing up the expansion of our Naples store. We're finishing adding 7,500 feet to our Boston store. So that said - and the Palm Beach Gardens one, which we referred to, which is having a very good response, was almost a 30,000 square foot addition.

Operator

Your next question comes from Chi Lee - Morgan Stanley.

Chi Lee - Morgan Stanley

Steve, you made a comment about second half inventories largely being driven by Direct and the Off 5th business. Can you talk about what, then, that implies for the inventory levels at the full-line stores?

Stephen I. Sadove

Yes, I think that it implies that the inventory levels in the full-line store will be flat, flattish. You know, right around plus or minus zero.

Chi Lee - Morgan Stanley

And for the end of question relative to the consolidated 1.9% increase in comp store inventories, can you talk about what full-lines ended the quarter with?

Stephen I. Sadove

We don't break out and report by the individual businesses, but you can infer that it's going to be lower than the total because we had more inventory growth in the Internet and the - you know, the Direct and the Off 5th.

Chi Lee - Morgan Stanley

And one last question for Kevin. Kevin, the days payable continues to come down. Can you remind us of what's driving that trend and how much lower that can go?

Kevin Wills

The payables leverage has decreased some year-over-year. If you recall over the last probably six quarters or so in '07 and late '06, we were making our inventory intensification efforts and so we were getting some natural leverage associated with that. As we're now reducing the inventories, you're seeing some decrease in the leverage. We have not changed payment terms or any vendor terms.

Operator

Your next question comes from Todd Slater - Lazard Capital Markets.

Todd Slater - Lazard Capital Markets

Steve, your operating margin this year looks to be coming in around the 2.7% range, down from about 4.3% last year, and I'm wondering if you feel that the 8% operating margin goal is still in the cards? And how long do you think it will take you to implement some of the recommendations that are coming out of your work with the consultant group?

Stephen I. Sadove

You know, I think that the question about the 8% operating margin, is it still out there, and the answer's absolutely yes. We're not backing off from that. I still believe that - you know, I don't feel good that we're not growing earnings this year. We were on a very good track and I feel like over the last three years we've made enormous progress, having gone from basically negative, zero, to 2 to 4, and I was hoping that we would be continuing on that path. It doesn't feel good that we're stepping back from where we were. But the programs, the strategies, we feel very good about and feel that the 8% can be achieved.

I don't want to give you a specific timetable right now because the environment is so volatile. I do know that the kinds of programs, whether it's the clienteling for full-price selling, putting in commission, putting in the right tools in terms of planning and allocation systems, are all the things that are going to drive - and the 9box and getting the right assortment by store - are going to drive the growth longer term, and it's a question of staying the course as opposed to backing off and going in the wrong direction.

In terms of the AlixPartners work and the cost structure work, I think it's early relative to that. And I do think that there are going to be opportunities there, and I wouldn't expect you to see major benefits from that in the fall season. I do think that you'll see the benefits of some of that in next year.

Todd Slater - Lazard Capital Markets

If you're able to reduce your cost structure due to this work, might you look at an even higher operating margin or EBITDA margin type of outlook in the long term?

Stephen I. Sadove

Well, I think that - you know, look. We've got a ways to go to get ourselves to the 8% level. I never viewed the 8% as being the be-all, end-all. We have competitors that are at the 11%-12% range. So if we can get ourselves closer to that level, great, but right now our focus is righting, you know, in terms of getting it to where we're back on the track towards the 8, and we're intently focused on doing that and managing the costs. I feel good that we're looking at the SG&A dollars, you know, absolute dollars as well as percent, and going to be aggressive on that. And that we're going to manage tightly the inventories and go after the full-price selling.

Operator

Your next question comes from Robert Drbul - Lehman Brothers.

Robert Drbul - Lehman Brothers

Two questions. The first one is on the private label initiatives, how have you dealt with, you know, what you planned to be private label going into the fall and sort of now your adjusted sales expectations? Have you been able to sort of make any adjustments to your orders on the private label? And what sort of magnitude should we expect in terms of the penetration rate as we go into the fall?

Ronald L. Frasch

Well, right now - Robert, hi, it's Ron - right now, you know, private label remains a low percentage of our overall inventory so there really wasn't a lot of adjustment that needed to be made. Probably the most interesting program that we have coming up is the reintroduction of Real Clothes, which is hitting the stores in the month of August, which is a more casual product to offer.

So as we go forward, we see private label playing a potentially more important role, but when all's said in done, we remain a pretty branded store, as you know.

Robert Drbul - Lehman Brothers

Are you at all concerned as you go into the fall that you're going to have too much private label?

Ronald L. Frasch

No. No, not at all, Robert. We have, I think, put in the appropriate amount of inventory. I think we have the right expectation levels. We've been able to react to the performance that we've seen, so I think we have the right balance of inventory to sales expectations.

Robert Drbul - Lehman Brothers

And just a pricing question. When you look at the environment and the promotional posture out there, how are you managing, you know, any discounting that's going on in sort of full-price vendor stores as they clear merchandise or as they, you know, try to drive traffic versus what you have in your stores? Like how do you manage that on a competitive basis?

Ronald L. Frasch

It's kind of a daily conversation. I guess there's two approaches. One, you can be reactive. One, you can be proactive. And so what we've tried to do is try to as best we can stick to our promotional calendar because if we wind up promoting a brand because someone else promotes a brand or category of product because someone else promotes a category of product, it makes a very confusing message to our core customers. And when all's said and done, we want to give them a balanced and organized promotional environment within our store and when it's appropriate to buy promotionally.

Operator

Your next question comes from Michael Exstein - Credit Suisse.

Michael Exstein - Credit Suisse

Can you talk about your forward capital spending programs - as you think about next year, where you're likely to be spending the balance of your capital spending. And coming back to I think Adrianne's question about the quality of the inventory, where do you think you are in the quality of your inventory, not the absolute level?

Stephen I. Sadove

Okay, let me talk first on the capital spend. We've said that this year our capital spend will be about $125 million, about 70% of which or so is on the remodels and on the expansions that we talked about earlier. We haven't given any guidance for '09 in terms of capital spend. I wouldn't anticipate that you are going to see a higher number than that at this point. You know, we're still developing the '09 plans.

I could tell you the kinds of things because right now Ron and I and the team are spending a lot of time looking at what are the highest return projects and which choices do we want to make for '09. We have a lot more opportunities than we have an appetite for dollars so we're just going to make some choices in terms of what needs to be done.

But the kinds of projects that are going to be done are very similar. Clearly, one of the bigger investments we make next year is going to be finishing up the designer floor in New York, and then we've also committed publicly that we're going to be expanding and redoing our Palm Desert store in California. So those are two of the big ones that we're going to be doing.

There'll be a number of others as well, but it's going to be more of the kinds of things that we're seeing the returns on, the absolute dollar amount, which we haven't finalized yet.

In terms of your question on the inventory, if I heard it correctly, was how do we feel about the quality of the inventory coming into the fall. And I think that - if I heard you correctly - and we feel very good about where we are on currency. Our clearance levels are down slightly from year ago and we feel quite good about where we are in inventory currency.

Michael Exstein - Credit Suisse

Okay, so the whole issue that the representative from Morgan Stanley brought up in terms of the payable leveraging, we shouldn't read in anything in terms of -

Stephen I. Sadove

No, you shouldn't read anything into that.

Operator

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

Dana Cohen - Banc of America Securities

Just following up - you may have talked about this, but I didn't hear - pricing, you know, given all the pricing pressures the luxury guys in Europe have had, how much is pricing up sort of year-over-year as you move into the fall?

Stephen I. Sadove

Well, I'll give you some numbers and we can talk about it. It's a hard one to give you a specific percent. I've seen price increases on the European goods ranging from zero percent to 20%. And, you know, if I had to pull a guesstimate out of the air, you're probably in the 10% to 15% range on much of the goods.

Now you also have, if I were to look at what is our increases, what increases are we taking, you also have a component in there which is mix because, as you're changing the mix of the product, whether you're moving more from good towards better or best you're going to be seeing a price component of that as well.

But if I had to give a number estimating, we're seeing somewhere in that average 10% to 15% type of range.

Dana Cohen - Banc of America Securities

And that's across categories?

Stephen I. Sadove

That's across - ex the - you know, I don't think you're seeing it as much in the cosmetics, but ex the cosmetics, I think that cutting across categories on the imports, that's - European imports - that's the kind of range in pricing.

Operator

And you have no further questions at this time.

Stephen I. Sadove

Well, thank you all very much, and we look forward to speaking with you at the end of next quarter. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

This Transcript
All Transcripts