Q2 2004 PAYLESS SHOESOURCE INC Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: Ladies and gentlemen, thank you for standing by, and welcome to the Payless ShoeSource second-quarter earnings conference call. At this time, all lines are in a listen-only mode. Later there will be a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded. At this time, I'd like to turn the conference over to Mr. Tim Reid.

TIM REID, DIRECTOR, IR, PAYLESS SHOESOURCE, INC.: Thank you, Kent. Welcome to our conference call for the second quarter of fiscal year 2004. My name is Tim Reid; I'm Director of Investor Relations. Our call today will be led by Steven Douglass, Chairman and Chief Executive Officer for Payless ShoeSource Inc. After we complete our prepared remarks, Steven, Rick Porzig, our CFO and I, will respond to any questions you may have.

Our prepared remarks today will discuss our business outlook and contain forward-looking statements. These statements and other statements that we may make today that are not historical facts are subject to a number of risks and uncertainties and actual results may differ materially. Please refer to today's press release for more information on these and other risk factors that could cause actual results to differ. Now, I'd like to introduce Mr. Steven Douglass, our Chairman and CEO. Steven.

STEVEN DOUGLASS, CHAIRMAN & CEO, PAYLESS SHOESOURCE, INC.: Thank you, Tim. This morning, Payless ShoeSource announced our results for the second quarter of fiscal 2004, which ended July 31st, 2004, and a series of strategic initiatives to position the Company for improved performance moving forward. In the second quarter, we achieved net earnings of $3.7 million and diluted earnings per share of 5 cents. The results include a noncash pre-tax restructuring charge of $37 million related to a series of strategic initiatives, which I will discuss shortly. After taxes and minority interest, the charge was $17 million or 25 cents a share on a diluted basis. During the second quarter of fiscal 2003, the Company achieved net earnings of 5.2 million and diluted earnings per share of 8 cents.

Payless ShoeSource is committed to serving the interests of our shareowners by building long-term shareowner value through improved execution of our core business strategy. During the second quarter, the Company decided to take action relating to 5 strategic initiatives. These initiatives are directed towards sharpening the Company's focus on the core business strategy, increasing profitability, improving the Company's operating margin and building long-term shareowner value. The strategic initiatives include the previously announced decision to sell or dispose of all 181 Parade stores and related operations; the sale or disposal of all 32 Payless ShoeSource stores in Peru and Chile and their related operations; the closing of approximately 260 Payless ShoeSource stores in addition to approximately 230 stores that had originally been scheduled for closing or relocation as part of the normal course of business in 2004; the reduction of wholesale businesses that provide no significant growth opportunity; and a comprehensive review of our expense structure and appropriate reductions to improve profitability. In fiscal 2003, operations related to the strategic initiatives had combined sales of approximately $210 million and net operating losses of approximately $29 million. I will comment briefly on each of the strategic initiatives.

The decision to exit Parade was based on the conclusion that its contribution to our core business strategy is diminishing. Parade, which offers mid-priced footwear and accessories in leather and fine fabrics for women, provided Payless the opportunity to develop relationships with footwear designers and branded footwear suppliers as well as a window on women's fashion direction. We believe that the Payless merchandising team now has a solid foundation of fashion knowledge and relationships. Therefore, it is now in the best long-term interest of our shareowners for us to exit Parade.

Regarding the Peru and Chile, we have previously disclosed operations in those 2 countries were not performing up to our Company standards. After careful review and many months of effort to improve performance in these 2 countries, we determined it is now prudent to focus resources on more profitable alternatives.

Regarding the closing of approximately 260 additional Payless ShoeSource stores, because of the weaker sales performance during the second quarter of 2004, our management team made the decision to accelerate the closing of approximately 260 stores despite the fact that their leases are not scheduled to expire for a number of years. This was a proactive decision to more quickly position the chain to increase profit and net margin and ultimately provide more return to the shareowners.

As to wholesaling, we have been exploring a number of small wholesaling opportunities over the past few years. The decision to reduce our wholesaling effort is also consistent with our intent to focus on our core business.

Regarding SG&A expenses, due in large part to our below-expectation sales performance, our SG&A expenses as a percent of sales have continued to climb over the past several years. In the years 2001 and 2, we reduced our head count and favorably impacted the year-to-year rate of expense growth. We are again examining our structure and intend to make reductions that will favorably impact SG&A. We estimate that the cost for lease terminations and severance related to the strategic initiatives could be in the range of 40 to $60 million. However, the final financial impact of the strategic initiatives is dependent upon the ultimate exit transactions. The present value of operating leases on all stores included in the strategic initiatives was $116 million as of the end of the second quarter 2004. We intend to complete these strategic initiatives by the end of fiscal 2004.

Turning now to our second-quarter 2004 financial performance, sales totaled $728 million, a 0.5 percent decrease from the second quarter of 2003. Our same-store sales decreased 0.9 percent during the quarter. Unit sales decreased by 8 percent and average unit retail increased by 8 percent in the second quarter of 2004 compared with the same period of last year. Our sales performance started strong during the second quarter of 2004 with same-store sales growth of 3.9 percent during the month of May. However, in June, sales softened across much of the country and many competitors in the apparel and footwear market appeared to take clearance markdowns earlier in the season. In addition, throughout the quarter, it is likely that the consumer buying patterns were impacted by higher energy prices. In July, Payless decided to remain less promotional than last year and therefore protect its gross margin. This was possible because of our tighter control of inventory relative to last year.

Gross margin was 31 percent of sales in the second quarter 2004 versus 27 percent in the second quarter of 2003. The improvement resulted primarily from fewer markdowns and more favorable initial markups versus last year.

Selling, general and administrative expenses were 26.2 percent of sales in the second quarter of 2004 versus 25.8 percent in the second quarter of 2003. The increase over last year reflects higher payroll costs, increased expenses for insurance, professional services related to the proxy contest, costs related to compliance with Sarbanes Oxley and the negative leverage of lower sales. These were partially offset by a $2.6 million decrease in advertising expense and lower medical insurance expenses relative to the second quarter of 2003. In addition, during the second quarter of 2003, the Company wrote off debt costs in conjunction with its debt restructuring. The rate of increase in SG&A narrowed in the second quarter relative to the past several quarters. …