Macy's, Inc.
Q4 2006 Earnings Call Transcript

Published: 27 Feb 2007

[Operator:]

Good day, everyone, and welcome to today’s Federated Department Stores earnings conference call. As a reminder, today’s conference is being recorded. Now, for opening remarks and introductions, I would like to turn the conference over to Karen Hoguet. Please go ahead, Madam.

[Karen M. Hoguet:]

Thank you. Good morning, everyone, and welcome to the Federated Department Stores conference call schedule to discuss our fourth quarter earnings. I am Karen Hoguet, CFO of the company. Any transcription or other reproduction of the statements made in this call without our consent is prohibited. A replay of the call will be available on our website, www.fds.com, beginning approximately two hours after the call concludes. Please refer to the investor relations section of our website for discussion and reconciliations of any non-GAAP financial measures discussed this morning. Keep in mind that all forward-looking statements are subject to risks and uncertainties that could cause the company’s 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 company’s most recently filed Form 10-K and Form 10-Q.

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[Operator:]

(Operator Instructions) We will first go to Deborah Weinswig with Citigroup.

[Deborah Weinswig:]

As we think about the gross margin guidance for 2007, I just want to make sure. It sounds a little conservative and if we think about the fact that you will have a full year of Federated’s Private label, the new Macy's doors, the use of 20/20 at the new Macy's stores should also theoretically help mark-downs, and obviously a host of other positives, can you help us understand what maybe we are not thinking about?

[Karen M. Hoguet:]

Well, the issue is -- remember, we are focused on giving the customer value. We are not focused on growing gross margin rates. We would much rather offer the customer value and get the rewards in comp store sales growth. So I think that is probably what you are missing.

[Deborah Weinswig:]

Okay, that is very helpful. Secondly, you had said on the last earnings call that Home Store had stabilized in the third quarter and you expect it to make more progress in the fourth. Did you see what you would have expected in the fourth and how are you thinking about 2007?

[Karen M. Hoguet:]

Yes, we have seen continued progress in the Home Store, both in the legacy Macy's doors as well as the new Macy's doors, which is really encouraging. We do expect that to continue to improve and obviously we expect a big benefit from the Home Store as we introduce the Martha Stewart line in the fall season.

[Operator:]

We will now move on to Dana Cohen from Banc of America Securities.

[Dana Cohen:]

A couple of questions; starting on the gross margin, I think you made a comment that I think it was shrink was better than expected in the fourth quarter. Is that correct?

[Karen M. Hoguet:]

That is correct.

[Dana Cohen:]

But would it be also fair to assume that the merchandising margins at the legacy Federated doors were better than expected, given the comp?

[Karen M. Hoguet:]

You know something, we do not track it that way, so I really do not know. But as I think about it, I would think those would be better, but in the May doors, remember we are dogmatic about clearing old age inventory and not carrying things over to a new season, so we took a lot of mark-downs, given the weak sales in the May doors.

[Dana Cohen:]

Okay, and then given that SG&A came in almost $100 million better in terms of dollars, was that primarily the synergies that drove that?

[Karen M. Hoguet:]

I believe it is, Dana. We are still analyzing it because it was much better than we had expected.

[Dana Cohen:]

So the offset in terms of -- I am now moving down the P&L to EBIT, would have been probably profitability if the legacy May doors were below expectations, given the sales and the gross margin?

[Karen M. Hoguet:]

I am not willing to say that. I don’t know.

[Dana Cohen:]

Okay, and then looking out to ’07, SG&A dollars in the quarter were at a run-rate of I think 270 below LY. Just help us to think about how we model ’07 given SG&A dollars running down so much year over year.

[Karen M. Hoguet:]

Well, that is not going to happen in 2007. SG&A as dollars will increase in each of the time periods. As you could tell from my comments, in the first-half of the year, because we are not year rounding on the synergies happening yet, you should expect bigger increases -- I’m sorry, lower increases than in the back-half of the year when in 2006, we were already experiencing the synergies.

[Dana Cohen:]

I guess I don’t quite get why you wouldn’t at least see SG&A dollars down in the first three quarters, since the synergies seem to have gotten pulled out in the fourth.

[Karen M. Hoguet:]

No, the synergies came out all through the year, Dana. It is just that by the fourth quarter, we had hit the run-rate. So we expect dollars to go up in each quarter. Not as much as the sales growth, obviously, because as I said we are expecting almost a point of improvement in the first quarter.

[Dana Cohen:]

Okay. Great, thanks.

[Operator:]

Now we will move on to Stacy Turnof from Merrill Lynch.

[Stacy Turnof:]

A question again on synergies. When we look at modeling that for the next couple of quarters, given the fact that part of that 450 occurred in the fourth quarter, how should we look at that? Is it really primarily going to be spread out through the next three quarters?

[Karen M. Hoguet:]

I am not quite sure how you are building your models. I have it just in the SG&A number, so within that guidance, where you see the rate improving almost a point in the first quarter, less in the second and flattish in the third, that is how I would think about modeling total SG&A.

[Stacy Turnof:]

Okay, that is helpful. My second question is, can you give us any comment on how your February home sale has done, particularly at the May stores?

[Karen M. Hoguet:]

Not until we report the month next week.

[Operator:]

We will now move on to Charles Grom with JP Morgan.

[Charles Grom:]

What has changed in the May doors in your view that has led to the improvement over the past 60 days? Is the home area improving and the key driver, or is the customer just getting more comfortable with the offerings since the banner change in September?

[Karen M. Hoguet:]

We are seeing improvement in all parts of the business, so I really think it is just time. I think we just expected the customers to respond immediately, and it does take time for people to absorb change and understand, so I think it is time more than anything else.

[Charles Grom:]

Just as a follow-up to that, I am just curious as to why you see comps up for the full year up 2% to 3.5% when I think formerly you were outlining at least 3%. Is it the May doors not doing as well as you thought, even though they are improving or is it something more macro?

[Karen M. Hoguet:]

No, it relates to the trend we are coming off of in the fourth quarter. I am still hoping to do the upper end of that guidance, but as we are thinking about reality, we thought it made sense to have a broader range.

[Charles Grom:]

One last one on merger integration costs, just curious as to why there was such a delta between what you guided to and what the end number came in at. I know you said timing. Was that entirely it? If you could just provide some granularity there.

[Karen M. Hoguet:]

Sure. A couple of things. One is that you will recall we were running under year-to-date, so some of the things that did not happen earlier ended up happening in the fourth quarter. That is largely the reason.

[Charles Grom:]

Okay, anything specific that wasn’t running on time?

[Karen M. Hoguet:]

No, it was just a -- it was a one-time cost that is very hard to predict the timing, so for example, some of the write-downs on real estate relating to warehouses, we had to wait until decisions were made and those decisions were made a little bit later, but really nothing and obviously not impacting the achievement of the 450.

[Operator:]

We will now move on to Adrienne Shapiro from Goldman Sachs.

[Adrienne Shapiro:]

Karen, you had mentioned that you had discussions with the ratings agencies. Any sense you can share with us how much debt capacity you could assume and still maintain investment grade status?

[Karen M. Hoguet:]

No, I really cannot comment. You would have to talk to the agency.

[Adrienne Shapiro:]

Okay, but any metrics that you are thinking about that you are comfortable with, a target that we should be thinking about?

[Karen M. Hoguet:]

Obviously it is all the normal credit ratios and it is a balance of all that -- the leverage amounts, fixed charge coverage -- it is all the normal credit ratios.

[Adrienne Shapiro:]

On the buy-back, could you just help us think about the pace of the cash flows? You had mentioned the $4 billion completed this year, but just any sense of cash flow out, paying down the buy-back?

[Karen M. Hoguet:]

I can tell you that I cannot help you there, but what I can tell you what we have assumed in the guidance, which is that the roughly $2 billion or the 45 million shares already happened and that the remaining roughly $2 billion is assumed in the guidance to be bought back over the back-half of the year.

[Adrienne Shapiro:]

Okay, so the first $2 billion is out?

[Karen M. Hoguet:]

Correct.

[Operator:]

We will now move on to Bob Drbul from Lehman Brothers.

[Bob Drbul:]

Just a couple of questions on the May doors. First of all, can you give us the blended numbers on 2006 that we will be comparing against when you give us the ’07 guidance?

[Karen M. Hoguet:]

No, because it really was not part of the comp base last year.

[Bob Drbul:]

Okay. The second question is when would you expect the May doors to start, the legacy May doors to start to comp positive in your assumptions?

[Karen M. Hoguet:]

You know something, I am not tracking it that way anymore, so I do not even know how to answer that.

[Bob Drbul:]

For full year 2006, could you talk a little bit about the advertising expense and where it came in on a dollar basis or percentage basis, and how to think about it in ’07?

[Karen M. Hoguet:]

I do not have that number yet for 2006, but as you know, it will be in the 10-K when we report. In terms of how to think about it for ’07, as you know, we do not expect a significant reduction in marketing expense other than what has already happened in the overlapping markets. But we are really investing in marketing to both build the brand while we are still keeping the sales promotion cadence that we have had in the past, so I would not expect any marketing savings in 2007.

[Bob Drbul:]

Okay, and then just one final question; when you look at the performance of your Private label business, have your targets at all changed in terms of where you think that business can go? I guess when you look at ’07 in general or ’08 and ’09, can you just maybe walk us through how you think that will progress?

[Karen M. Hoguet:]

My guess is it will increase slightly, but what we have really been focused on is exclusives also, not just Private brand. So for example, Martha Stewart is not technically a private brand but that is part of what we call exclusives and we are going to continue to build that. Don’t know how far we will go there but obviously we love having differentiated assortments, so we would like to continue to push the penetration of exclusives, private brand and limited distribution product, which in ’06 together was about 35% of our sales.

[Bob Drbul:]

Are you contemplating anymore door closures with Federated or the whole doors, Macy's or Bloomingdale’s?

[Karen M. Hoguet:]

We are not expecting anything significant. As you know, every year we look at under-performing stores and close those that are under-performing but I do not expect a significant number at any point.

[Operator:]

We will now move on to David Glick from Buckingham Research.

[David Glick:]

A quick question on the cost savings. Previously, your guidance for the synergies was $175 million in ’06 and 275 in ’07, if I got those numbers correct. How much did you realize in ’06 and what is left as incremental for ’07?

[Karen M. Hoguet:]

You know, it is really hard to measure that with any precision, David, so clearly we achieved more than the 175 in 2006 and that is why SG&A did better than what we had expected. Within the plans that I have talked to you about and the SG&A guidance, we know has at least $450 million, so what the precise number is, I am not sure I can tell you that at this point.

[David Glick:]

I am getting a lot of questions on this and I had it myself, the degree to which you exceeded the 175. Was it substantial, significant? I am just trying to get some color as to really how much more you exceeded that in some qualitative way.

[Karen M. Hoguet:]

I think it was substantial.

[David Glick:]

Okay, so probably the majority of the cost savings were realized in ’06? Is that fair?

[Karen M. Hoguet:]

David, I do not want to get pinned down too specifically because I do not know, but clearly more than 175. But there is still a lot more to happen in the first-half of ’07 also.

[David Glick:]

Okay, and then just to follow-up on the former May doors, can you give us some color on the degree of improvement as you proceeded through the fourth quarter? Is it possible to give us some measure, whether it is relative to plan or relative to last year, just a sense of how much they have improved and what you think --

[Karen M. Hoguet:]

Let’s just say they have improved enough that we are comfortable with the guidance we are giving you for the first quarter.

[David Glick:]

And the biggest drivers for the improvement, was it home or execution?

[Karen M. Hoguet:]

It was across the board. That is why I said earlier I really do think it is time that has elapsed and given customers and associates time to get used to the change.

[Operator:]

We will now go on to Teresa Donahue from Neuberger Berman.

[Teresa Donahue:]

My question has been answered for now. Thank you.

[Operator:]

We will now move on to Dana Telsey from Telsey Advisory Group.

[Dana Telsey:]

Can you talk a little bit about minimum wage increase? Does that impact the business at all, or how have you accounted for it? On the CapEx, breakout of remodels, new stores, how are you seeing it this year? Thank you.

[Karen M. Hoguet:]

There is really no change in the CapEx. Obviously of the $400 million we spent on conversion, we are not doing this year. So if you strip that out in terms of the mix between new stores and remodels and technology and direct-to-customers, it is pretty much as it has been. Not a lot of change there. I admit, Dana, I do not know the answer on the minimum wage. Historically that has not been a big issue for us because our people are above that level but I do not know the answer to your question.

[Operator:]

We will now move on to Michelle Tan from UBS.

[Michelle Tan:]

I have a follow-up question on the synergies. I believe you said that you were in the fourth quarter at a run-rate of around the $450 million. It seems like there are opportunities still in the first-half of the year with a number of D.C. closings still scheduled and I think the systems conversion in the Midwest still ahead. Could you elaborate on some of the areas of potential additional savings in the first-half?

[Karen M. Hoguet:]

We have said that systems are now all converted as of the beginning of February, so that happened at Macy's North and Macy's Midwest and that is now done, and the distribution center integration is ongoing and in fact, you are right. That is another source of the added savings in ’07 versus ’06. That is why the SG&A estimates for the first and second quarter are a lot more aggressive than the back-half of the year.

[Michelle Tan:]

Then, from a total savings standpoint, that does imply that there should be something. I know you are saying at least 450 now, but does that imply that we should see something in excess of at least that 450?

[Karen M. Hoguet:]

Correct.

[Michelle Tan:]

Then, just to understand on the buy-back, is that being funded from the cash on the balance sheet and cash from operations or is there some additional debt that is associated with that?

[Karen M. Hoguet:]

The $2 billion that we have just completed will be funded with cash on hand and commercial paper. However, as you look through the year, we have about $650 million of debt maturing, so we will be refinancing that as well as funding some of the additional buy-back.

[Michelle Tan:]

And then one final question, just on the May stores, or the converted May stores versus the legacy Federated, can you give us any sense of the average unit retail gap between those two sets of stores and whether you have seen that close at all with the change in the assortments at the May locations?

[Karen M. Hoguet:]

Yes, there is a gap. Yes, it has begun to narrow, and I do not know the specific number. But that clearly was part of the strategy here as we move their doors to our mix of good, better, best. We still see opportunity from that, which has helped obviously drive the comps.

[Michelle Tan:]

I am not sure if you have this color or not, but the May customers, in terms of where they are shopping on the price point mix, do you see them starting to convert more to those higher price points?

[Karen M. Hoguet:]

We absolutely are. If you think about what sold well in the May doors, it was some of the better goods, the status brands, the private brand, the differentiated product. I do not know why there is this impression that May customers are different than the former Macy's customers. They are the same. So exactly what is working in the Macy's stores will work in the May doors. By the way, as you know, we do not sort our stores sort of in a one-size-fits-all. We have lots of stores that are in more moderate trading areas that were Macy's doors just like we have May doors, but there is this perception of a big difference in the customer. There really isn’t.

[Operator:]

We will now move on to Michelle Clark from Morgan Stanley.

[Michelle Clark:]

You had mentioned that the comp trend at the May company doors has been improving since mid-December. Does that include February month-to-date? If it does, is the rate of improvement in February consistent with what you have seen in January as you transition for more full price sales?

[Karen M. Hoguet:]

It does include February but I am not going to say a lot about February sales until next week.

[Michelle Clark:]

Okay, so it does include February. Secondly, what are you guys doing specifically to get the customer to notice better value in the stores?

[Karen M. Hoguet:]

A lot of it has to do with marketing. A lot of it has to do with sales associate training, so that they could say to a customer, this is a great value, you don’t need a coupon. A lot of it has to do with the communication we can do as these customers have opened up Macy credit cards as part of the Star Rewards program. Part of it is being patient and just letting time evolve. It is important that people know that even though Macy’s uses coupons a lot less than what May had done, we still offer fabulous value to the customer and in part, as I responded to Deb earlier on the call, value is a very important part of what we are offering. Differentiated assortments at good values. It is just helping that customer to understand it through sales associates as well as marketing.

[Operator:]

(Operator Instructions) We will now move on to Jeff Stein from KeyBanc Capital Markets.

[Jeff Stein:]

I am wondering if you could just walk us through the structure of this $2 billion stock transaction that you just completed. A, what date was it completed and B, under what conditions will there be an adjustment to the dollar amount that you have purchased?

[Karen M. Hoguet:]

Essentially, we executed this transaction for the 45 million shares in two pieces, and the only difference between the two pieces really is the degree of control we have over the maturity. So for half of those shares, we have signed an agreement and in essence, it has gone into autopilot. We have very little to do with it and that agreement will be terminated sometime between two and five months from now. On the other half, we do have control over the time period and while we suspect we will get it done in around the same time, we do have more flexibility there. In both cases, when these agreements are terminated, we will pay more or less for those shares depending on what the stock price does between now and the termination date. At that time, we will settle either in stock or in cash.

[Jeff Stein:]

Could you tell us what you have baked into your guidance in terms of a settlement price?

[Karen M. Hoguet:]

No. That would tell you what I think is going to happen with the stock price.

[Jeff Stein:]

Okay. One more question, real quickly. Can you give us your guesstimate in terms of growth in working capital for the year?

[Karen M. Hoguet:]

I think we are expecting to see inventory begin to grow slightly. We do still expect to have turnover improvement, but with the sales increase that we are talking about, we do think there will be some increase in inventory for the year. Obviously payables react to the receipt levels that we have also.

[Jeff Stein:]

Okay, and the settlement tuxedo rental business, I presume that has not closed yet, and when it does, how much money will come into the till?

[Karen M. Hoguet:]

It has not closed yet and as you know, the price for that was $100 million and that will be reduced by the amount of deposits that have been received for tuxedo rentals to come. So when we had hoped to close it at the end of January, that was a fairly small number. When we think we will close it, the deposits will be a bigger deduct, only because that is the middle of prom season and wedding season. So my guess it will be somewhere and I do not know for sure, around $70 million.

[Operator:]

We will now move on to Rob Wilson from Tiburon Research.

[Rob Wilson:]

Thank you. On the last conference call, you mentioned inventory levels at historical May stores were running lower than the Macy's stores. How does that look today?

[Karen M. Hoguet:]

I do not remember saying that they were lower, so I am not quite sure what I am responding to, but they are now being run identically, so inventory levels should be on the same, based on the sales expectations across the company.

[Rob Wilson:]

When Martha Stewart launches in the fall, do you expect your home business penetration will increase, and is that penetration around 15% for your total home business?

[Karen M. Hoguet:]

Yes, we expect it to increase and I think it is around 15%. I have not looked at the year-end number, so I am not positive but it is that ballpark. But for sure we would think it would increase due to some of the new categories that we expect to come with Martha.

[Operator:]

Thank you. That does conclude our question-and-answer session. I would like to turn the conference back over to Ms. Karen Hoguet.

[Karen M. Hoguet:]

Thank you all again for your interest, and obviously if you have more questions, Susan and I are both available to answer whatever you may have. Have a good day. Thanks.

[Operator:]

Thank you. That does conclude our conference for today. Thank you very much for your participation. Have a great day. What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price? This is exactly what Seeking Alpha is offering with transcript sponsorships. Six types of companies are sponsoring earnings transcripts on Seeking Alpha