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"We've had limited blunt tools to work with…" – Michael Massey, CEO

It’s rare that we start off a note with a quote, but this one sums up PSS’ positioning over the 2H of 2011 pretty well. Despite this unfortunate circumstance, Q4 results suggest there are indeed signs of operational improvement underway – even if that improvement is simply getting rid of excess baggage of money-losing stores.  The offset is that while PLG blew out its revenue line, backlog slowed sharply.

The real question is whether these two changes on the margin are enough to impact the break-up of the company (90% of the reason why people own this thing).

We think it’s net neutral to positive.

  1. PLG: The key callout at PLG was the deceleration in Q1 PLG backlog up only +1% and down sharply from +17% in Q4. It’s worth noting a few items that are contributing to the decrease including 1) faster lead times so customers can order closer to need, 2) greater mix of auto-replenishment, 3) lower off-price and mid-tier bookings, and lastly 4) weather. It’s also important to recall that PLG production capacity was more constrained last year requiring a greater portion of backlog orders to secure the timing of orders, which is no longer the case. All in, it’s easy for the company to simply place blame here – as many companies do when orders slow or inventories build. They’ll need to explain this in far greater detail for someone buying the company outright. But enough of the factors at play pass the smell test for us initially.
  2. Payless Domestic: The simple fact that store count was down by 310 sequentially – or 6.5% -- at the same time we saw comps accelerate by 400bp sequentially (on a 1, 2 or 3-year basis) is proof positive for us that there’s value in the core. Check out our past research on store closure sensitivity. We’re gaining comfort with this part of the equation. We like the fact that we’re seeing some numbers work while the bankers are negotiating through the press for the highest bid. 

As we look out to 2012, we made a few adjustments to our model including a 1pt increase in comp to +3% with Q4 results turning positive, offset in part by a reduction in PLG wholesale growth to +11.5% from +12% reflecting weaker Q1 backlog trends. Offsetting these drivers is ~$120mm in lost revenue from underperforming store closures in F12, which we had previously modeled. The net result is a modest increase in our revenue growth estimate for next year to +1.6%.

We have gross margins expanding 106bps driven by fewer markdowns and easing product cost headwinds as well as modest SG&A leverage -30bps. The biggest delta is a lower tax rate (not exactly a high quality adjustment) accounting for the majority of the $0.10 increase to our F12 EPS estimate to $1.07 and $1.54 for F13.

PSS: Domestic Drag Improves - PSS S