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Troubled Times for SFAE: Martin Vows to Do Better After $42.8M Loss in Qtr.

Even as parent Saks Inc. reported a profit for the second quarter, its Saks Fifth Avenue Enterprises division had an operating loss of $42.8 million.

NEW YORK — The pressure is building on Saks Fifth Avenue’s management team.

Even as its parent, Saks Inc., on Monday reported a profit for the second quarter, its Saks Fifth Avenue Enterprises division saw an operating loss of $42.8 million. The loss prompted Saks Inc. chairman and chief executive officer R. Brad Martin to promise Wall Street analysts during a conference call, “I expect improved business discipline and execution at Saks Fifth Avenue Enterprises going forward.”

SFAE showed a 4.2 percent comp gain in the quarter, but its loss widened from just $6.2 million in the year-ago quarter. The retailer suffered a substantial decline in gross margin rate and increased operating expenses during the period. The company also said the quarter was “challenging” due to the activities surrounding the recently completed audit investigations, which caused disruptions among merchant and planning teams.

But the SFAE team — led by chairman and ceo Fred Wilson and including president Andrew Jennings and vice chairman Ron Frasch — recognizes there is work to be done.

“During the quarter, business was not as robust as we had expected,” said Wilson in a statement. “We are in the process of exiting certain products, such as certain private brand merchandise, that we do not feel are consistent with the Saks Fifth Avenue brand.”

He noted that as a positive, the New York flagship of SFA on Fifth Avenue, which the company operates as a “laboratory,” achieved a “significant increase” in sales for the quarter.

Wilson explained during the conference call that the year-over-year second-quarter gross-margin decrease was due primarily to two factors: “Unsatisfactory inventory management led to increased markdowns, and we experienced a decline in vendor markdown support.”

He explained in response to an analyst’s query that the problem with inventory management was not an issue going forward. “The inventory management at Saks really was a result of the systemic, what I call a dysfunction that we’ve gotten corrected.”

Wilson added that as SFA was exiting certain products, it also was also making focused investment in high growth-opportunity businesses such as contemporary, modern and designer sportswear; women’s and men’s shoes, and handbags. In addition, Wilson noted there is an “overall upward movement in price points with the average price per transaction increasing approximately 7 percent thus far in 2005.”

Wilson said during the call that the division’s merchants, under Frasch’s supervision, will fit private label into the overall assortment each is responsible for, and that there won’t be a separate private label group.

As for its merchandise, the luxury chain will focus on “modern merchandise and key items” for holiday. While premium denim still shows some growth and is a “big business that’s still increasing,” Wilson noted the growth has slowed from its “rapid increase” from a year-and-half ago.

Martin added during the conference call that, “while Saks Fifth Avenue Enterprises continued to progress on a number of important strategic initiatives during the first half of 2005, execution at this business segment was simply not satisfactory. Actions associated with the audit committee investigations of improper markdown allowances clearly took their toll on the organizational focus and the operating results of Saks Fifth Avenue Enterprises during the first half of the year.”

For the three months ended July 30, income at Saks Inc. was $8.2 million, or 6 cents a diluted share, against a loss of $25.3 million, or 18 cents, in the same year-ago quarter. Sales fell by 2.6 percent to $1.32 billion from $1.35 billion.

For the six months, income was $24.4 million, or 17 cents a diluted share, versus a loss of $5.2 million, or 4 cents, in the year-ago period. Sales dipped by 0.9 percent to $2.87 billion from $2.89 billion.

It was in part a $57 million gain, or 40 cents a share, from the $622 million sale of its Proffitt’s and McRae’s businesses to Belk in July that helped put Saks Inc. in the black for the quarter.

As for its divisions, operating income at its department store group dropped by 36.8 percent to $2.4 million from $3.8 million, although same-store sales gained 0.5 percent as total sales declined 5.8 percent due in part to the sale of the Proffitt’s and McRae’s stores.

Steve Sadove, vice chairman and chief operating officer, said in a statement the decline in operating performance was “entirely attributable to the operations of Proffitt’s-McRae’s, with only two months of operations included in the quarterly results.” He noted the remaining businesses in the department store group, mainly the Carson Pirie Scott stores, showed a “modest positive comparable-store sales gain and solid operating performance for the quarter.”

Parisian, he said, generated a low-single-digit comp-store sales increase.

Martin noted that Saks Inc. is “continuing the strategic alternative process” for its northern department store group, consisting of mostly the Carson Pirie Scott stores, and its Club Libby Lu specialty retail business. He skirted a question during the call regarding the time frame for when the company would look at its SFA business and possibly even consider strategic alternatives. While Martin emphasized that the northern stores division is a very healthy business and is a “real strong cash generator,” it was the board that concluded it was “time to consider options that could create value beyond retaining and operating that business.”

As for Saks Fifth Avenue, Martin would only say that, with respect to the balance of the group’s assets, it is “very focused on executing to our operating plans.” He did leave the door open, stating that, at such point or event the “board believes there is a superior path, I know they would entertain that.”

Analyst Kevin Boler of Merrill Lynch wrote in a research note that Saks Inc.’s weak second-quarter performance “should jeopardize chances of profitably selling off either Saks Fifth Avenue or the department store group. Although the company cites ‘distractions’ such as the audit committee investigations into improper markdowns, we suspect financial buyers will now place steep discounts on any future bids for either the [department store group] or SFAE.”

The company said reasonable assumptions for the second half of 2005 include flat to low-single-digit comparable-store sales growth at the department store group and midsingle-digit comp-store-sales gains at SFA. It also expects a flat gross margin rate on a year-over-year basis.