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Coldwater Creek, Inc. (NASDAQ:CWTR)

Q3 2005 Earnings Conference Call

November 22, 2005, 3:45 p.m. CT

Operator:

Welcome to Coldwater Creek's third quarter earnings release conference call.

Today's call is being recorded.

With us today we have Mr. (Dennis Pence), Chairman and Chief Executive Officer, President and Chief Merchandising Officer, Ms. (Georgia Shunk Simmons), Mr. (Mel Dick), Executive Vice President and Chief Financial Officer and Mr. David Gunter, Divisional Vice President Corporate Communications and Investor Relations.

Mr. Gunter, please go ahead sir.

David Gunter:

Thank you operator.

Good afternoon and welcome to Coldwater Creek's fiscal 2005 third quarter earnings release conference call.

If you have not received a copy of the release distributed this afternoon, please contact our office at 208-265-3977 and we will send one out to you immediately.

We will begin with a few formal comments from management and then open up the lines for your questions.

During the course of this conference call we may make forward-looking statements regarding future events or performance of the company including forward-looking statements and projections about our operating results, business initiatives, growth opportunities and prospects. I want to emphasize that any projection involves judgment and that individual judgments may vary. Any projections we make today are based on information available to us now which is subject to change as the quarter progresses. Actual results may differ substantially from what we say today and no one should assume later in the quarter that the comments we provide today are still valid. More over, we are not undertaking any obligation to provide updates in the future. The documents the company files from time to time with the Securities and Exchange Commission including our most recent Form 10-K and Form 10-Q contain and identify important factors including the risks and uncertainties described under risk factors. That could cause actual results to differ materially from those contained in any forward-looking statements.

A replay of this conference call will be available immediately after the call today until midnight on November 29th. The number to call for the replay is 719-457-0820 and the pass code is 9614479. The web cast of this call will also be available on the investor relations page of our web site until November 29th after which the transcript of this conference call will be posted. To access that information, visit www.coldwatercreek.com and select investor relations.

And now I would like to introduce (Dennis Pence).

Dennis Pence:

Thank you David and welcome back ladies and gentlemen.

I am pleased to report that better than anticipated sales and profits in the third quarter resulted in an increase in market share for both our retail and direct segments. In addition, we have seen momentum building over the last four weeks as we move toward the all important holiday season. The continued successful execution of our retail store roll out increased our store count by 27 stores in the third quarter, the largest number of stores we have ever opened in a single quarter. We will open the last store we have planned for 2005 tomorrow which will take us to our goal of having 174 locations in place for the holiday selling season. Based on the effectiveness of our retail expansion this year, we have announced that we now plan to increase our roll out for 2006. As previously reported, we currently plan to open 65 stores next year, up from our original plan of 60. Additionally, we have increased our average store size for the coming year by approximately 500 square feet, a 10 percent increase. We believe this additional space will allow us to more fully represent the brand in the retail setting and increase overall revenue on a per store basis.

The Coldwater Creek catalog has proven to be an effective store traffic driver and we plan to further leverage this successful marketing tool by expanding this initiative next year. We'll have more information on this during (George's) comments.

Our national magazine ads continue to generate positive results as a brand building initiative in the third quarter. Based on favorable customer response, we expanded our advertising program to include an eight page advertising insert in major women's magazines for the holiday season. Also adding to our brand awareness is the recognition we received last week from the National Retail Federation which named Coldwater Creek the number one specialty apparel retailer for customer service in the United States and number two in customer service for all retail companies overall. This award was based on survey results for more than 8,500 consumers across the country. Providing excellent service has always been a hallmark of the brand in our catalog and Internet channels and we're especially pleased to have earned this recognition for the service we provide in our retail stores.

Once again, this past quarter Internet growth was stellar with our Internet site traffic exceeding 12.9 million visits during the third quarter, an increase of 72 percent compared with a year ago. Including the new names added during the recent quarter, we now have nearly 2.6 million active email addresses. More than 66 percent of the customers on our email list now live within 30 miles of a Coldwater Creek retail store. We continue to leverage both our growing email list and catalog mailings to drive retail store traffic and promote special events.

Turning now to a brief overview of our third quarter financial performance, the data is as follows. Net income increased 37 percent to $12.4 million resulting in earnings of 20 cents per share compared with 15 last year. Operating margin for the quarter was 10.3 percent. Improved merchandise margins and leveraging of our full line retail store occupancy costs resulted in a 220 basis point improvement in the gross profit rate. Net sales increased 26 percent due to solid response to our fall merchandise collection. We ended the quarter with a cash position of $104 million, working capital of 125 million and zero debt.

In regards to the retail segment, net sales from the retail segment increased 44 percent to 115 million in the third quarter. Retail stores represented nearly 61 percent of our total net sales for the third quarter compared with approximately 53 percent a year ago.

In regards to the direct segment, our overall direct segment net sales increased seven percent due to continued growth in the Internet channel. Internet sales increased 21 percent in the third quarter compared with the prior year. Internet sales represented nearly 63 percent of our direct segment net sales for the period.

Catalog sales decreased 11 percent in the third quarter as we continued to use catalogs as our primary print advertising medium to shift more customers to the Internet and drive traffic to our retail stores.

In summary, strong sales performance at the beginning and end of the third quarter more than offset the negative impact of Katrina and its aftermath which was contained to the first three weeks of September. Ongoing execution of our retail store expansion strategy remains a top priority for the company and we now plan to open 65 stores in '06. We plan to open the last store in our 2005 retail expansion tomorrow which will give us a total of 174 stores supporting the brand as we enter the holiday selling season. We believe the positive impact of an expanding national store base, ongoing growth in our Internet channel and effective brand building initiatives continue to increase our market share while taking us another step closer to the goal of establishing Coldwater Creek as one of the premiere specialty retailers in the United States.

Now I'd like to turn the call over to (Mel) for a more detailed review of third quarter financial results.

(Mel) . . .

Mel Dick:

Thank you (Dennis).

Net income for the third quarter was 12.4 million or 20 cents per share. This represents an increase of 37 percent over the net income of 9.1 million or 15 cents per share we reported in the third quarter last year.

Our consolidated net sales for the third quarter increased 26 percent to 190.1 million from 150.5 million in the comparable period last year. This increase was a result of strong customer response to our fall merchandise in August and October and an increase of 56 retail stores compared with the prior year.

Net sales from our retail segment increased 44 percent to 115.2 million for the fiscal 2005 third quarter from 80.1 million in the prior year period. Our retail segment net sales represented 60.6 percent of the company's total net sales in the most recent quarter compared with 53.2 percent a year ago.

We had 163 full line stores in operation at the end of the third quarter compared with 107 full line stores in the prior year period. Currently we have 173 full line stores in operation with the addition of 10 locations that have opened so far in the fourth quarter. We are scheduled to open our final store of the year tomorrow, successfully completing our plan to open 60 stores in fiscal 2005.

Net sales from our direct segment increased seven percent to 74.9 million for the third quarter compared with 70.4 million in the 2004 period. Our direct segment net sales represented 39.4 percent of the company's total net sales in the most recent quarter compared with 46.8 percent in the prior year.

Internet sales increased 21 percent to 47 million in the third quarter compared with 39 million last year. Internet net sales represented 62.7 percent of the company's direct segment net sales in the third quarter compared with 55.4 percent in the fiscal 2004 period.

Catalog net sales decreased 11 percent to 27.9 million for the quarter compared with 31.4 million a year ago. This decrease was primarily due to customers from the catalogs continuing to shift to our retail and Internet channels. Catalog net sales represented 37.3 percent of the direct segment net sales for the period compared with 44.6 percent in the prior year third quarter.

Gross profit for the third quarter was 90.8 million or 47.8 percent of net sales compared with 68.6 million or 45.6 percent of net sales for the same period last year. This 220 basis point increase in gross profit rate was primarily due to improved merchandise sales margins in the direct segment and to a lesser extent, improved leveraging at the company's full line retail store occupancy cost.

Selling, general and administrative expenses for the fiscal 2005 third quarter were 71.1 million or 37.4 percent of net sales compared with 53.4 million or 35.5 percent of net sales for the third quarter of 2004. The increased in selling, general and administrative expenses expressed as a percentage of net sales was primarily due to increased personnel costs associated with our retail store expansion and to a lesser extent, increased national magazine advertising.

For the recent quarter, income from operations increased 4.5 million or 30 percent to 19.7 million or 10.3 percent of net sales. This compares with 15.2 million or 10.1 percent of net sales in the prior year period.

Turning to the balance sheet, we closed the quarter with 113 million in inventory, an increase of 21.9 million compared with the end of the third quarter last year. This increase in inventory was primarily due to the addition of 56 retail stores since the third quarter of last year. The 24 percent increase in inventory came during a period when we had 52.3 percent increase in store count and a 45 percent increase in retail square footage compared to the third quarter of 2004. At the end of the third quarter, we had no short or long term debt and a cash position of 104.7 million. At the same time, the company's working capital increased to 125.6 million at the end of the period from 111.2 million in the comparable period a year ago.

In regards to our Coldwater Creek co-branded credit card program, we had more than 60,000 activated cards during the third quarter which resulted in credit card revenues of more than 4.5 million for the period. This represents a substantial increase over the credit card revenues of just under 1.7 million in the second quarter of this fiscal year when we introduced the program. As of the end of the third quarter we had a total of more than 81,000 activated cards and we continue to see growth in this program.

Finally, updating the status of our distribution center expansion in West Virginia, we are planning to add approximately 350,000 square feet to the existing facility which will bring our total space there to almost one million square feet. Construction is expected to start later this year. We plan to take possession of the new space in the second half of fiscal 2006 and believe that with this expansion our single distribution facility will be sufficient to fulfill up to 450 to 500 retail locations going forward.

In summary, our merchandising and marketing initiatives for fall resulted in positive customer response across all channels which contributed to an increase in net sales and net income for the quarter.

I will now turn the call over to (Georgia) for a discussion of our merchandise results for fall and a look at what's in store for the holiday.

Georgia Shunk Simmons:

Thanks (Mel).

Once again in this recent quarter, customers responded very well to our iconic novelty jacket and top assortment but new for us has been the excellent response to our pattern and prints skirts. We had a higher degree of confidence in our merchandising strategy going into the fourth quarter and based on positive early response, we remain enthusiastic about the holiday selling season.

As always, holiday at Coldwater Creek is about items and gift giving. We approach the season with a warm and cozy traditional feeling and of course some innovative twists. Everything about our holiday collection was carefully designed and all of our categories this year emphasize multiple gifting. For instance, we have novelty tops and sweaters with many dyed to match accessories and colorful suede jackets with matching suede gloves. Along with items like these, we are featuring an assortment of fun merchandise including stocking stuffers. That puts a focus on the gift giving that's so important to us. We believe that we have a distinct strategic advantage this time of the year because of the categories we offer. We dress her, our customer, for 10 months out of the year and although we continue to dress her throughout the holiday season, we really become her gift destination as we get closer to Christmas. The way we merchandise gifts and hard goods with our apparel continues to set us apart from the competition and it becomes an even bigger differentiating factor in the all important gift giving season. For early holiday, we have seen particular strengths again in our novelty jackets, knit tops and great fun accessories.

Our current gift with purchase promotion has proven to be an exciting addition to this successful program. Customers are responding extremely well to our amethyst earring and necklace set. The gift with purchase strategy is one that works well for us driving traffic to our stores while it gives the customer an attractive incentive to spend $100 or more to receive their gift.

Another very successful initiative has been our Coldwater Creek catalog, a title which features mostly store specific merchandise from all of our catalog titles under one cover. Based on positive response to this store traffic driver which by the way also performs very well in the direct segment, we are increasing circulation for this book next year and in 2006 we will have six mailings of the Coldwater Creek catalog, up from five mailings this year.

As (Dennis) mentioned, our national magazine advertising campaign has become an effective brand building tool and we are reaching out to a greater number of customers this holiday season with an eight page insert in high circulation titles such as Oprah, Better Homes and Gardens, More, Country Living and Good Housekeeping. In November and December, our total page count will exceed one half billion pages of Coldwater Creek brand messaging.

I'm also pleased to report that our inventory position came in under planned for the third quarter even with the addition of 56 new stores compared to the prior year. In addition, our inventory is more current than in the past due to the effectiveness of our well managed virtual inventory and our single distribution center. Retail inventory increased approximately 15 percent on a square foot basis to $70 per square foot compared to 61 in the prior year. This increase was primarily due to our merchandise built up and the preparation for the holiday season.

Turning to our global sourcing initiatives, we are on track to achieve our goal of having 15 percent of our volume direct source this year and remain confident that we can meet or exceed our goal of 50 to 100 basis points improvement in gross margins associated with direct sourcing. Next year we plan to increase that amount of merchandise sourced directly to approximately 30 percent. We also plan to open our Hong Kong office in January which will play an important role in our ability to increase the level of direct importing going forward.

In closing, overall we were pleased with the response to our merchandise in the third quarter thanks to good sales in August and October. We continue to see customer response to our retail store expansion as very positive as well as strong growth in our Internet channel which had a 21 percent increase in net sales compared to last year and now represents nearly 63 percent of our direct segment net sales. Our brand building initiatives, the national magazine advertising and the Coldwater Creek catalog traffic drivers continue to perform well for us driving sales in both the retail and direct segments. Inventory levels are below plan at the end of the period and our inventory is more current than in the past. At the same time, we added 56 stores that increased retail square footage by 45 percent compared with the same period last year and although it's still early, we are seeing very positive response to our holiday assortments in all three selling channels and we are very enthusiastic about the balance of this important selling season.

That concludes my comments. I'll now turn the call over to (Dennis).

Dennis Pence:

Thank you very much (Georgia).

Before we open up the lines for your questions, I'd like to update you on our guidance for the remainder of this fiscal year. Based on the positive early response to our holiday assortment and what we see as potential upside for this selling season, we are increasing our fourth quarter and full year net sales and EPS guidance to reflect the following: fourth quarter net sales in the range of 245 to $250 million and EPS of 24 to 25 cents. That makes the full year an increase in guidance to reflect net sales in the range of 745 to $750 million and an EPS of 69 to 70 cents.

We'd like to now open up the call to your questions. Thank you very much.

Question-and-Answer Session

Operator:

Thank you.

The question and answer session will be conducted electronically today. If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touch-tone telephone. If you are using a speakerphone, please remember to make sure your mute function is turned off to allow your signal to reach our equipment. Again, that's star one if you would like to ask a question and we'll pause for a moment to assemble our queue.

And our first question comes from Ann Poole with (Kevin Davenparts).

Ann Poole:

Hello. (Georgia) I just was wondering as gift cards have become more important in the holiday season, have you adjusted your inventory flow for December and January? Will the stores receive more full priced goods during this time than they have in the past or are you doing anything different to address this?

Georgia Shunk Simmons:

Gift cards have become an ever growing part of the holiday season and the business and so there are – that's already baked into our plan for us to be able to not only sell them but of course redeem in January and February.

Ann Poole:

OK. So you do have full price floor sets that flow in January and December.

Georgia Shunk Simmons:

Yes absolutely. Even though January becomes the sale period and the big sale period, we always have full capsules and full price spring merchandise coming in again to give the customer some newness.

Ann Poole:

OK. And then I guess regarding sale, it appeared that the clearance sale in the retail sales lasted a little longer this year than last year before the goods were moved to the outlets and the Internet and I just was wondering was this planned and is this something we can expect to see as the retail store base continues to grow at a greater rate than the outlets?

And then also in the past you continued to have solid full price sales during your clearance events and was this also the case in the third quarter?

Georgia Shunk Simmons:

Let me answer that. The first question about the sale lasting longer, in prior year, in 2004 we stopped the sale a week before the end of October and brought holiday goods in prior to Halloween. Strategically this was not a good move for us so we decided that again the consumer, especially our customer, is not ready to even think about holiday until after Halloween is over so we added an extra week at the end of October to clear fall goods and not bring holiday in too early. So that was a strategic plan and we'll continue that next year.

And I'm sorry. Can you repeat the second question?

Ann Poole:

I just was wondering are you still seeing that you have strong or full priced business during while your clearance events are going on as well?

Georgia Shunk Simmons:

Yes we have continued to see all year and including in October that every time that we bring full price merchandise in and the front of the store in (capfuls of newness) that the customer responds exceptionally well.

Ann Poole:

OK. And then just one last question, can you comment how the expanded petite offering is doing and have you received you know good feedback on that and do you see this as a growth opportunity going forward?

Georgia Shunk Simmons:

I would say that we have seen very positive response to the petite offering being expanded. We are continuing to look at into it and this will be – we'll keep the expansion going forward and looking into other areas.

Ann Poole:

OK. Thank you.

Operator:

Again ladies and gentlemen, that's star one if you would like to ask a question.

We'll move to Richard Jaffe with Legg Mason.

Richard Jaffe:

Thanks very much and congratulations guys. It's a really great quarter.

Georgia Shunk Simmons:

Thank you.

Richard Jaffe:

A question on the marketing initiatives in the third and fourth quarter, the increase in media advertising or print media, you had talked about this as sort of an interesting test in the third and fourth quarter. I'd like to know what you learned in the third quarter, what kind of measurable results you've seen either in new email or catalog customers and then if you could comment on the deferred marketing expense in this quarter and the sudden build up in that.

Dennis Pence:

I'll take the first one Richard and (Mel) might wish to talk to the second one here in just a second.

We saw very clearly that we had a remarkable competency a year ago in terms of what I'll call print media advertising that really we'd previously defined as our catalog channel and we saw a very good way to refocus that into magazine advertising so that we could now begin to attract a customer who was not a catalog customer to the brand and move them into the stores and we're seeing a fairly high percentage, about one out of four customers who are responding to these magazine ads have never heard of Coldwater Creek, have never purchased from Coldwater Creek before and it is really providing some great incremental new business for the company across the three channels but primarily of course going into the retail stores and secondarily into the Internet site. Based on what we seen the success of it, it does two things. It really leverages the beginning of creating a brand umbrella over the entire company's portfolio of offerings across all the channels and I think as for us at this stage Richard it's a much more cost effective way to do that than for television and second, it certainly drives traffic immediately right to the stores and we did see that opportunity and we are seeing it as we speak.

Mel Dick:

Richard regarding the question on pre-paid advertising increasing, there's really two components of that. one is some increase in our bringing in catalog paper early because of an opportunity to bring it in at the prices we wanted to and then also the national advertising campaign we have the ability to tie those sales to those particular offers so there is some pre-paid advertising costs related to the magazines that would be in home in November and December and it's those two components that caused that increase between years.

Richard Jaffe:

I guess you've talked about seven million in additional advertising in the fourth quarter. Should we assume that some of that was paid for in the third quarter?

Dennis Pence:

Some of that might have early – yes actually some of that would have been paid for and would have been – some of those magazines would have been in home right around the end of the third quarter, the beginning of the fourth quarter. The number that we actually are spending I think is roughly $6 million for the quarter.

Richard Jaffe:

So that will be in addition to what we saw today in the release.

Dennis Pence:

Well a majority of those dollars are setting in the pre-paid advertising cost at the end of the quarter or some portion of them are and then we'll be spending some for the December ads that will go in home or are currently on the newsstands.

Richard Jaffe:

Right. So you'll enjoy the benefit but they're already paid for.

Dennis Pence:

The cash flow has already taken place.

Richard Jaffe:

Right.

Dennis Pence:

But the expense will amortize as we see the sales.

Richard Jaffe:

I see. OK.

Dennis Pence:

It's very similar to the accounting that we have for pre-paid catalog costs.

Richard Jaffe:

Right. So . . .

Dennis Pence:

((inaudible))

Richard Jaffe:

Cash flow adjustment is made immediately and then as the catalog gets mailed or as the ads run you'd take the expense.

Dennis Pence:

Right. Richard if there is a – there is a coupon attached to these ads with an offer code so from an accounting perspective we can track the sales curve of the ads, that the ads are responsible for by the redemption code on the coupon that the consumer redeems so it's different than just the normal ad that is designed to increase awareness but has no coupon with a code that you can track and that's why you have to defer it and then amortize it over the life of the sales.

Richard Jaffe:

Now you anticipated my next question. What's the response on a percentage basis to your ads? Would you say you know Home and Garden is a million book distribution and you know do you get 100,000 responses to that or can you – have you tried to quantify it in that way?

Dennis Pence:

We can quantify it. I can assure you it wouldn't be anywhere near 10 percent. It is a small percentage but as a I say, so many are new to file that it seems to be very positive for us.

Richard Jaffe:

That's great. Thank you very much.

Operator:

Our next question comes from Carol Buyers with Cordillera Assistant Management.

Carol Buyers:

Hi. How are you guys?

Dennis Pence:

Good.

Mel Dick:

Good.

Carol Buyers:

I was wondering could you detail just this quarter how many catalogs you mailed out and then what the expected number of catalogs you're expecting to mail out next quarter?

Georgia Shunk Simmons:

Yes in Q3 we mailed out approximately the same amount of catalogs as we did in Q3 of '04 which is in the – it's in the area of about 43 million.

Carol Buyers:

And then what's the expectation for the fourth quarter?

Georgia Shunk Simmons:

For the fourth – for the fourth quarter again we will be very close to what we mailed last at about 109 million.

Carol Buyers:

OK. And then – so it's flat once again?

Georgia Shunk Simmons:

Yes.

Carol Buyers:

OK. And then jumping just onto the SG&A line, when you commented in the press release that you opened an extraordinary amount of stores this quarter, what was the impact on it from a basis standpoint on the margin?

Dennis Pence:

Basis standpoint on the margin, it'd be easier to look at it from a standpoint of opening up 27 stores and that probably had an impact of roughly a penny and a half or a million and a half dollars of pre-opening costs.

Carol Buyers:

OK. That's a – yes I guess ((inaudible)) OK. Great. Good quarter.

Dennis Pence:

Thank you.

Operator:

And we'll move to Lyn Walter with Wachovia Securities.

Lyn Walter:

Hi thank you. A couple of questions; can you talk about the improvement in gross margin, how much of that was related to your direct sourcing initiative?

Mel Dick:

Yes Lyn. This is (Mel).

Our improvement in gross margin really there's two major components of it. A little over 100 basis points was related to the merchandise margins improving and of that I would say probably half or so was related to direct sourcing. The other improvement was from leveraging our total occupancy cost related to our retail stores and that improved the margin about 100 basis points as well.

Lyn Walter:

OK. Thanks. And then just again in terms of SG&A, in your guidance for Q4 of 24, 25 cents, can you just give us a sense of the SG&A dollar growth that that's embedded in there because I know it's been up considerably and I assume without the store openings it should be a little bit less going forward.

Dennis Pence:

Yes, I don't have a specific dollar growth that's embedded in there but it'll be – the growth rate will be approximately the same as the third quarter.

Lyn Walter:

OK. Does your guidance assume SG&A leverage then in Q4?

Mel Dick:

There would be some leverage in Q4 because we wouldn't have the number of new store field operation people coming on. However, we do have the significant national advertising campaign going on.

Lyn Walter:

OK. Great. Thanks and good luck.

Operator:

And our next question comes from, I'm sorry, Amy Noblin with Bank of America.

Amy Noblin:

Great. Thanks and let me add my congratulations. Just going back to the SG&A piece for a second, can you break down the increase in advertising expense and I know you've outlined some numbers for Q4 but what we should expect to see in 2006.

Dennis Pence:

Well on 2004 or 2005 here, there really are two components to the growth in the SG&A. As I mentioned, one was the increase in store people – store operating personnel and then the second was on our national advertising campaign. I don't think I have the percentages at my fingertips that you asked for Amy.

Amy Noblin:

OK.

Dennis Pence:

And then we haven't yet given out any information relative to 2006.

Amy Noblin:

OK but I mean any qualitative commentary in terms of what your advertising plans might be in 2006?

Dennis Pence:

Well certainly ((inaudible))

Amy Noblin:

I mean I would assume that you would expand the print advertising but . . .

Dennis Pence:

Certainly qualitatively we are seeing first of all the print advertising, magazine advertising we are going to continue and selectively expand. That is based on the individual magazine. We'll be trying some new magazines as well outside of the some of the traditional shelter magazines number one and number two as (Georgia) eluded to, the Coldwater Creek catalog which is particularly determined to drive retail traffic will be expanding and adding an additional drop so we will see our SG&A rise on an absolute dollar rate due to those two initiatives. I think very important to recognize it is a wonderful opportunity while we have such great residents with the customers right now in this age group is to solidify our reputation with new customers as new competitors potentially come into this sector. We really do want to prudently increase our brand advertising over the next couple of years.

Amy Noblin:

OK. And just a couple more questions, maybe if you could talk a little bit about the timing of new store openings within the quarter, how it progressed and then last on inventories, I believe (Georgia) mentioned they were up 15 percent at retail due to some early receipts for holiday. What do you think is the ongoing increase during the quarter as we head into Q4 and where do you expect to end the fourth quarter?

Dennis Pence:

I'll take the question on the store openings. We really built up the stores. There was 27 stores in the third quarter and the majority of those stores were opened in the last two months of the third quarter.

Georgia Shunk Simmons:

OK. And then talking about the inventory, we will end the inventory year at about $46 per square foot. That includes the (DC) and that's very, very similar to last year. So it should come down nicely.

Amy Noblin:

OK. Great. Thanks and good luck for the holiday.

Georgia Shunk Simmons:

Thank you.

Dennis Pence:

Thank you.

Operator:

We'll move to Roxanne Meyer with CIBC World Markets.

Roxanne Meyer:

Great. Hi. Let me add my congratulations on a terrific quarter.

Georgia Shunk Simmons:

Thank you.

Dennis Pence:

Thank you.

Roxanne Meyer:

I was wondering if, I know it's early but will you – are you willing to share for next year the timing of your new stores by quarter?

Dennis Pence:

Yes, we would anticipate that we will do that but I don't have that right now. We'll be doing that later. I would say the break out in the stores this year I think we had five stores in the first quarter, 11 in the second I believe, 27 in the third and then 11 in the fourth. I think I'm off a little bit on the second quarter but the ratio will probably be approximately the same for the 65 next year.

Roxanne Meyer:

OK. Great. And then can you describe the margin differential, the product margin differential between your non-apparel items versus your you know more of the gifting and accessory items?

Georgia Shunk Simmons:

Yes absolutely. All of our – first of all just we do about you know 86 percent of our business in apparel. That is our largest IMU because we design all of our own products and in jewelry and accessories the IMU is also high. Where we have lower IMUs happens to be in the gift and hard goods and somewhat in footwear because again we're not doing as much product development.

Roxanne Meyer:

OK. And is that 86 percent for the full year or is that fourth quarter?

Georgia Shunk Simmons:

No actually it goes down a little bit in the fourth quarter.

Roxanne Meyer:

OK.

Georgia Shunk Simmons:

So the – and that's really – the 86 percent really is annualized and actually in the fourth quarter we usually do about 75 percent in apparel and pick up the rest in gifts, accessories and jewelry.

Roxanne Meyer:

OK. Thanks. Good luck on a – on a terrific holiday.

Georgia Shunk Simmons:

Thank you.

Operator:

And we'll move to Marc Bettinger with Stanford Group.

Marc Bettinger:

Hi everyone. Congratulations. A lot of questions have been asked so just a few; (Mel) when do you expect to hit 15 percent as an operating margin? What year?

Mel Dick:

That's going to be in the 2008 time frame. At the point – there's really two keys to meeting that for us. One is the continued build out of the stores and being able to leverage the store operating costs and the purchasing volumes from the stores and we would expect to see some leverage from our stores on an SG&A basis starting in 2007 when we hit probably 225 to 250 at stores and then the other major component is the direct sourcing initiative that (Georgia) spoke to. When we hit about 70 percent direct sourcing which will be in 2008, we would then expect the combination of those two items to give us the opportunity to have a 15 percent operating margin.

Marc Bettinger:

OK. So for the year of fiscal 2008 we would expect you to have a 15 percent operating margin.

Mel Dick:

If we can achieve our strategic initiatives and continue to execute yes.

Marc Bettinger:

OK. So then from here we'd be looking for you to increase the operating margin about two percent per year. I'm assuming roughly nine, nine and a half percent this year.

Mel Dick:

The increase – we'll still have some increase in SG&A next year so I think we see the leverage really beginning in '07. We'll start to leverage near the end of '06 when we have 225 or so stores in place by the end of next holiday.

Marc Bettinger:

OK. Also the merchandise margins in retail, I know you mentioned them in the direct segment but in the retail segment was there any differential or . . .

Georgia Shunk Simmons:

No actually because the merchandise really is all the same so you're looking pretty much at the – at the same elements.

Marc Bettinger:

I'm sorry (Georgia), the same numbers?

Georgia Shunk Simmons:

Yes you're looking at the same numbers sorry.

Marc Bettinger:

OK. And also just quickly on the balance sheet, am I reading this right that the it looks like the inventory on a per store basis was down and that the accounts receivable have jumped ahead of the growth in sales?

Dennis Pence:

Yes there's three – you're correct on the inventory. The receivables though have a couple of different components in there. There's really three major pieces. One just in general sales were up year over year because of the increased stores so the credit card receivables were up. Secondly the credit card fees that Coldwater Creek receives on our co-branded program was up. That was something that we didn't have a year ago and then lastly with the addition of 27 stores plus 11 in the fourth quarter, our tenant allowance receivables are up substantially year over year as well.

Marc Bettinger:

OK. All right. And so the account receivables though in relation to sales, are they pretty much in line?

Dennis Pence:

They are in line with the growth that we've had in sales yes.

Marc Bettinger:

OK. And I'm sorry on the per store inventory it looks like it's actually down relative to the number of stores you've added on a year over year basis.

Dennis Pence:

On a per square footage though basis though I think (Georgia) mentioned it was up roughly 15 percent the total inventory available to the retail stores.

Marc Bettinger:

OK. And the 15 percent (Georgia) that's on plan?

Georgia Shunk Simmons:

Actually the 15 percent is actually under plan and the reality is we will be back at the end of the year to where we were last year at approximately $46 a square foot including the (DC).

Marc Bettinger:

OK. So then going into holiday though I mean I realize this is a static number at the end of the quarter of the 15 percent being below plan but does that mean that going into holiday you'll be where you want to be?

Georgia Shunk Simmons:

Yes we are positioned exactly where we want to be for this quarter.

Marc Bettinger:

OK. Congratulations on a great quarter.

Georgia Shunk Simmons:

Thanks Marc.

Marc Bettinger:

Thank you.

Operator:

And Deena Friedman with (Breen Murray) has our next question.

Deena Friedman:

Good afternoon. Congratulations. Very nice quarter.

Georgia Shunk Simmons:

Thank you.

Deena Friedman:

Questions for you (Georgia), last quarter you talked about adding more accessories to the mix. Can you just give me an update as to where that stands?

Georgia Shunk Simmons:

Yes absolutely. When we – we've been continuing to add more (substance) to the mix and certainly we do as we get into the gift giving season. So strategically not only did we add more we actually did a lot of our own product development and really added as I said in my remarks the addition of which I think is great is the multiple gifting. So you don't just buy the sweater. You buy the sweater and the hat or the sweater and the gloves or scarves or hand bags that go and have actually been designed to go together so it makes it very easy for our customer to purchase gifts and they make a really wonderful presentation besides great quality merchandise as you open up the box. So yes we have increased it.

Deena Friedman:

Excellent. And a question in terms of the hurricanes, can you give me a sense of what the store closures were like and any negative impact it might have caused?

Dennis Pence:

We really didn't see heavy store closures. We didn't have any stores in New Orleans at all but we did see nationwide for that first two weeks after the hurricane a reduction in store traffic and we also saw that our North Country catalog that dropped the same weekend that the hurricane hit the coast did have very poor sales associated with it. we did see this effect clear but it certainly seems that the clearing almost was inverse relationship of the amount of publicity, the TV coverage, all the sadness and bad news and it seemed like our customers responded to that very much and certainly I think the good news from the point of view of the investors on the call is we saw then in October the vibrancy of the business return to exactly where it was in August which was very strong so it certainly seems as though it was a highly unusual event and luckily it was over very quickly. We're lucky that there weren't additional disasters that occurred subsequent to that.

Deena Friedman:

Absolutely. And then (Mel) one question for you, when I look at accounts receivable at a percentage of sales it looks like it's up on a year over year basis. Is that the same issue of tenant allowances that you had last quarter?

Mel Dick:

Yes it's a combination of tenant allowances with the more stores opening up year over year and also the fees that we received from our co-branded credit card. There's a delay in when we actually receive those fees so that you see this year. We didn't have that program last year.

Deena Friedman:

Excellent. Congratulations.

Georgia Shunk Simmons:

Thank you.

Mel Dick:

Thank you.

Operator:

Susan Sansbury with Miller Taback.

Susan Sansbury:

Hi, it's Miller Taback. Thanks for letting me ask a question.

Georgia?

Georgia Shunk Simmons:

Yes.

Susan Sansbury:

Hi.

Georgia Shunk Simmons:

Hi.

Susan Sansbury:

Do you have any plans to reinvest any of your sourcing savings by going direct and upgrading piece goods quality thereby creating better value – a better value proposition to drive store traffic? I know you mentioned at the analyst meeting that you didn't expect to raise prices so are you going to in any way change the price value equation?

Georgia Shunk Simmons:

No actually I think maybe the better way that I can answer this is we worked very early on the type of piece goods that we use. They are tested rigidly to make sure that they will provide the customer with comfort and also quality so at this point what I look at is getting the best value for this customer and we actually price things by looking at them. You know what is this really worth in the consumer's mind and our mind and – but we do intend to remain competitive but I think we offer actually a really nice product for the value. So that's what I want to continue to maintain and again execute that on a continuous basis.

Susan Sansbury:

So you have no – at the moment you have no intention of – for example I saw cashmere sweaters in Kohl's. You have no intention of replacing polyester acrylic fabric with a natural fiber?

Georgia Shunk Simmons:

Well actually we run quite a bit of natural fiber. The problem with cashmere is that everybody is in cashmere including Wal-Mart so it's very difficult to compete in it and we find that our customer prefers to be able to wash and wear and so that's why our faux cashmere has been so successful for us.

Susan Sansbury:

Well I didn't mean to focus on cashmere but cotton as opposed to polyester or a polyester blend as opposed to 100 percent polyester.

Georgia Shunk Simmons:

We do carry – we do carry natural fibers and we carry both natural fibers all 100 percent but we also do carry blended fibers today and one of the reasons that we do is actually the technology in both yarn and in piece goods has gotten to the point that actually the wearability and the quality is much better.

Susan Sansbury:

OK. Trivia question, whatever happened to (tencel)?

Georgia Shunk Simmons:

(Tencel) is still around but what happened was is that there are again because of technology there are fibers that actually react and really make a stronger and better piece goods that are less expensive. (Tencel) still tends to be because it's wood based a very expensive piece of goods and we run (tencel) jackets constantly because our customers do like them so it's still around but not what it was before.

Susan Sansbury:

OK. Great. Thanks very much.

Georgia Shunk Simmons:

You're welcome.

Operator:

And we'll move to (Kevin Pull) with (Magnatar).

Kevin Pull:

Hi guys. Congratulations on a great quarter.

Georgia Shunk Simmons:

Thanks (Kevin).

Kevin Pull:

And just going back to one of the changes you guys seem to be making is on the store size. You've done a great job of kind of tweaking that model over the years and really getting a great return out of it and it seems like some of the stores you're opening going forward are going to be a little bit bigger. Can you just kind of walk through what you're seeing there?

Dennis Pence:

Sure (Kevin). This has been really an organic process over the last three years and it's kind of a Goldilocks phenomenon, you know too big, too small, just right and we originally built stores just a very small quantity of them that were too large and then as an initiative we reduced the size and as they initiative a couple of years ago we looked at stores quite small relative to where we had been and as we analyzed the sales per square foot, we saw that we did not see any higher sales per square foot in the smaller footprint stores than we were seeing out of stores that were 20 percent or 25 percent larger and this was true across geographical areas whether it was a mall or a lifestyle center and so it became really obvious that we were leaving money on the table and given the breath of the merchandise assortment it was not a better proposition from an earnings perspective to all of our shareholders to build these stores that small and at the same time we remain highly focused on an efficient store model so it looked like and we think we are now just about at the most efficient place with this about 5500 square foot average. Now some will be 4500. Some will be 6500 depending on the market and the number of customers in that market but it was really a result of the analysis of the sales per square foot of the very small stores and the recognition we were leaving money on the table.

Kevin Pull:

Great and you guys some of the best returns out there. That's for sure.

Can you – can you at all comment on kind of the competitive situation? Are you seeing as over the last year – have you been able to quantify how many of your customers have kind of come away from the (Jill) brand and come to the Coldwater Creek brand because they've kind of strayed away from their core customer?

Dennis Pence:

Well yes, I'm happy to comment on the question and really and this is something – I talk about it internally a lot, really if you look at where our customers the majority of the customers in this population segment continue to shop it's department stores and the department stores make up more women's apparel over the age of 35 than the specialty people and the big box people put together substantially more and even though the department store share keep shrinking, they still are getting a huge percentage of the business. Now our customers don't like shopping there as much as they used to and we honestly believe that that's where we're picking up share more than anywhere else and the amount of total volume done by all the specialty apparel peers put together is not really significant compared to the department store so our focus is on finding ways to attract these customers to our brand and take this business as aggressively as we can from these department stores.

Kevin Pull:

OK. Great. And when can we expect – are we thinking the first quarter or the first half of the year roughly in terms of starting to report the great same store sales that you guys are generating?

Dennis Pence:

We expect that when we have 100 stores in the comp base for a full quarter we'll start reporting and so when we report second quarter earnings of 2006 is when we would start that reporting.

Kevin Pull:

Second quarter. Great. Thanks.

Dennis Pence:

Thank you.

Operator:

That's star one if you would like to ask a question.

We'll move to Lauri Brunner with US Bank.

Lauri Brunner:

Hi thanks. (Georgia), a couple of questions for you and then I'll move onto (Mel). Can you give us an update on sport and then dresses as well?

Georgia Shunk Simmons:

OK. In sport we continue to have especially in the sport sets we really continue to have great success. So we will be going forward for spring with our sport book. Also dresses, dresses are very interesting. As you well know, for our retail stores, they're really more sportswear oriented but quite frankly the dress business in direct both catalog and the web has been on fire and so we're really, really pleased with our dress business and we will continue to do the dress business which you know represents a large portion of the direct business.

Lauri Brunner:

Right. And then (Georgia), have you commented on your plans for (sirk) for '06 and then if you do one incremental Coldwater Creek titled catalog for '06 does that mean anything for the frequency of spirit or north country?

Georgia Shunk Simmons:

No the – we really haven't really done the '06 plans yet. That'll be done at a later date.

Lauri Brunner:

OK.

Georgia Shunk Simmons:

But we will be adding the one extra mailing of the Coldwater Creek catalog to drive traffic to the stores.

Lauri Brunner:

OK.

Georgia Shunk Simmons:

We'll talk about that later Lauri.

Lauri Brunner:

OK. And then (Mel), what is your annual advertising expense expected to be in fiscal '05?

Mel Dick:

I think it's going to be approximately 12 to 13 million. That's related to the national ads, the national ads.

Lauri Brunner:

OK. And how does that compare to '04?

Mel Dick:

To '04, we spent a little over three million on national magazine ads.

Lauri Brunner:

OK. Great. And then (Mel) you know sourcing is already contributing it appears on that gross margins but what's happening on the cost side of that business? You know I think people are trying to get at you know the SG&A number here in the quarter and I'm just wondering if there were some additional costs from sourcing that you saw in Q3 this year or has it been fairly linear with what you've seen earlier in the year?

Mel Dick:

Well partly the SG&A on a rate basis, certainly we had two weeks in September where we would have liked to seen a little bit better revenue.

Lauri Brunner:

Right.

Mel Dick:

And certainly had that been in there I think your model would have plugged in a little better.

Lauri Brunner:

OK. That's great. Great job to you all and good luck.

Georgia Shunk Simmons:

Thanks Lauri.

Dennis Pence:

Thank you.

Operator:

And it appears there are no other questions in the queue at this time. I'd like to turn the conference back over to you Mr. Gunter for any final remarks.

David Gunter:

We'd like to thank everyone for joining us this afternoon and wish you a very pleasant evening.

Georgia Shunk Simmons:

Thank you.

Operator:

This does conclude today's conference and we thank you for your participation. You may disconnect at this time.

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Source: Coldwater Creek Inc. Q3 2005 Earnings Conference Call Transcript (CWTR)
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