Tween Brands, Inc. Q3 2008 (Quarter End 11/1/08) Earnings Call Transcript

Tween Brands, Inc. (TWB)

Q3 2008 Earnings Call

November 19, 2008 9:00 am ET

Executives

Julie Sloat - Vice President - Investor Relations

Rolando De Aguiar - Chief Financial Officer, Executive Vice President

Michael W. Rayden - Chairman of the Board, Chief Executive Officer

Analysts

John Morris - Wachovia Securities

Kimberly Greenberger - Citigroup

[Tom Filnaro - FIG]

Margaret Whitfield - Sterne, Agee & Leach

Linda Tsai - MKM Partners

Barbara Wyckoff - The Buckingham Research Group

[Rick Patel] - Merrill Lynch

Tracy Kogan - Credit Suisse North America

Adrienne Tennant - Friedman, Billings Ramsey & Co.

Richard E. Jaffe - Stifel Nicolaus & Company

Marni Shapiro - The Retail Tracker

Dana Telsey - Telsey Advisory Group

Howard Tubin - RBC Capital Markets

Analyst for Brian J. Tunick - J.P. Morgan Securities

Presentation

Operator

Welcome to the Tween Brands third quarter earnings conference call and webcast. At this time all participants are in a listen-only mode. The question and answer session will follow the formal presentation. As a reminder, this call is being recorded and will be available for replay approximately one to two hours after this conference has ended. It is now my pleasure to introduce Vice President of Investor Relations of Tween Brands, Julie Sloat.

Julie Sloat

Thank you for joining us today to discuss Tween Brands third quarter performance. With me here today are Mike Rayden, Chairman and CEO, and Rolando De Aguiar, Executive Vice President and Chief Financial Officer.

Before we begin this morning I want to remind you that our discussion today will include statements about Tween Brands’ future expectations, plans and prospects for the company which constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those listed in today’s press release and in our SEC Form 10K.

I’ll now turn the call over to Rolando for commentary on the third quarter performance and then Mike will make a few comments on the state of our business and the transition to the Justice brand.

Rolando De Aguiar

This morning we reported third quarter earnings excluding an $11.5 million pre-tax restructuring charge of $0.26 per share versus the $0.46 we earned last year. Net sales for the quarter were down 3% driven by an 11% decrease in comp store sales compared to last year. This is comprised of a 4% comp store sales decline at Justice and a 13% comp store sales decline at Limited Too.

This is the first time in its history that Justice has posted a negative comp number which is indicative that it too is not impervious to the broader macroeconomic pressures that we continue to read about. However we are confident that the decision to move to the Justice brand is the best course of action for the sustainable success of Tween Brands, and Mike will speak about that more in a moment.

We experienced margin compression in the third quarter of 2008 predominantly due to the inability to leverage costs against the comp store sales decline and a full quarter of interest expense. Specifically, gross income was $85.6 million for the quarter and gross margin was $33.7 million in line with the 33% to 35% guidance range that we previously provided to you for the second half of the year but down from the 36% in the 2007 period. Merchandise margin declined this year as we were more aggressive with markdowns in an effort to generate sales.

Additionally, despite our buying payroll costs decreasing $2.4 million total buying and occupancy expenses increased $3.4 million from the third quarter of 2007. The increase was entirely a function of higher occupancy expenses associated with the 91 stores opened since the end of the third quarter of 2007.

SG&A expenses declined but increased as a percentage of sales to 28.4%. The $3.6 million reduction in home office expenses was largely offset by an increase in store operations expenses.

Net interest expense was up $1 million to $1.8 million during the period reflecting a full quarter of interest charges on the debt incurred for the accelerated share repurchase program in September 2007 and $803,000 in the third quarter of 2007 reflected about 1.5 months of incurred net interest expense.

We posted net income of $6.4 million excluding the restructuring charges or $0.26 per share. Including the $11.5 million pre-tax restructuring charge recognized during the period we posted a loss of $0.8 million or $0.03 per share. Weighted average shares outstanding on a diluted basis were 24.8 million for the third quarter of 2008 compared to 28.3 million in 2007. Our outstanding shares decreased as a result of the accelerated share repurchase program.

We are committed to conserving capital and maintaining liquidity as we navigate the difficult economic landscape. As a result we are again reducing our capital investment projection for 2009 to a range of $10 million to $15 million from our most recent forecast of $30 million to $35 million. We expect 2008 capital expenditures to be between $65 million and $70 million.

At the end of the third quarter our liquidity position was comprised of $61.4 million in cash and equivalents and our $100 million revolving credit facility. We also have another $50 million available through the accordion feature of the credit facility.

Taking a look at our balance sheet you will see that our current ratio as of the end of the quarter was 2 and the debt-to-equity ratio was 0.9. Cash flow from operations for the nine months year-to-date was $8.9 million versus cash flow from operations of $35.6 million last year.

Before I talk about our expectations for the remainder of the year, I would like to quickly mention that our total inventory at the end of the quarter was down 5.2% per square foot at cost from the end of the second quarter of 2007. In-store inventory was down 6.1% per square foot at cost consistent with our expectations.

Since the end of the third quarter of 2007 our total square footage has increased 11.5% to 3.9 million square feet. Our company opened 27 Justice stores and three Limited Too stores during the quarter. We remodeled two Limited Too stores during the period also.

We witnessed considerably challenging market conditions in the first two weeks of November and we believe the visibility for the holiday season has become murky at best as we navigate unprecedented economic conditions. For this reason we are electing to withdraw our previous guidance for the second half of 2008 and hold off on providing specific earnings guidance for the fourth quarter or full year. We want to avoid multiple gyrations and revisions to our guidance and as a result believe this is the best course of action today.

I do feel very comfortable telling you that we are going to be diligent about our expense management, very disciplined in our capital investment levels, and drive to preserve cash. We are also employing aggressive promotional activities to do everything within reason to generate earnings during what is likely to be one of the weakest holiday seasons in many, many years.

Before we open the call up to your questions, Mike Rayden would like to make a few comments about our business and how the transition to Justice is going.

Michael W. Rayden

I’d like to make a few quick comments this morning to provide you with an update on our business and then we will get right into your questions.

As you know, market conditions continue to be incredibly challenging given the far reaching economic pressures being experienced in our country and around the globe. Here at Tween Brands as we continue to see our moms increasingly struggle to respond to their daughters’ needs, we are even more confident that switching to the Justice brand is the appropriate course for the longevity and future success of our company.

Justice continued its outperformance relative to Limited Too and delivered positive year-over-year net sales growth which provides us with further reinforcement of our decision to transition to the Justice brand. So we are working ardently to execute our transition activities with great emphasis on informing and attracting customers.

I know that everyone is anxiously awaiting the holiday season and speculating about what should be expected given the mounting economic pressures. We are no different in that regard and I can tell you that we believe the holiday season is going to be one of the toughest the retail space has experienced in years.

As Rolando mentioned, in an effort to assist our customer and drive sales we are offering deeper holiday season discounts than we have in the past at both Limited Too and Justice. Specifically we launched J Bucks at Justice in late September and stepped up the promotional activity by doubling the distribution of both the J Bucks and Fun Cards. We are also offering double distribution of the Too Bucks and Bonus Cards at Limited Too.

Additionally in our most recent catazine we increased the percentage off savings included on the Daisy card and Super Saver cards, both of which now offer savings of 30% and 25% respectively as compared to 25% and 20% in the previous catazines.

On the transition to the Justice brand I want to make sure that everyone understands that the new Justice store will offer the best of both worlds, meaning the best of the former Justice and Limited Too teams and merchandise offerings. This is a critical element that I want to be sure no one misses since we believe it underpins our ability to be successful in converting the current Limited Too shopper to a Justice shopper, maintaining our current Justice and dual-brand shoppers, and attracting and converting new customers.

Specifically the team leading the Justice organization today is representative of the best talent we had at both Limited Too and Justice. We took advantage of this unique opportunity as we combined the workforces and therefore begin our journey in a position of strength as we transition to one brand.

The new merchandise offering will also represent the best of both worlds by including items representative of the entire fashion pyramid continuum versus the 80% that have been offered in the past by each brand.

Today and historically Justice has been widely successful at offering merchandise covering the bottom 80% of the fashion pyramid with quality, basics and hottest fashion apparel. Conversely, Limited Too has been successful at offering quality, hottest fashion and fashion forward apparel covering the top 80% of the pyramid. The new Justice will offer the entire fashion pyramid: Quality, basics, hottest fashion and fashion forward merchandise.

However the general price points will be at the historic Justice price range with the exception of the Limited Too layer that will be offered at 200 of our best stores and online and will remain at the higher traditional Limited Too price range.

So we are going to continue to support both brands and work toward the brand transition throughout the fourth quarter. To effectuate a successful transition we are following a detailed comprehensive plan as follows.

In September we completed our spring buy consisting of Justice apparel exclusively with the exception of the Limited Too layer that will be offered in select stores and online. We executed the buy with our combined best-of-both-worlds team and apparel offering. The newly joined team is now in the process of summer development which looks fantastic at this point.

The success of our customer transition can be greatly influenced by our sales teams at the store so we engaged in major road shows over the past several weeks to meet with our leaders in the field to be sure that they are trained appropriately and have the communication tools that they need to be successful. In January we will be using our direct mail catazine to communicate with all of our customers: Limited Too customers, Justice customers and dual customers who currently shop at both brands. We intend to communicate the following customized metrics:

One. To the Limited Too and dual shopper we will communicate that Justice is the new Limited Too and that we are transforming the style, sophistication and quality she knows and loves into the Justice brand to offer her better value.

Two. To the Justice customer we will communicate that the Justice brand will now be offering even more great style, fashion and quality for less and will now be in many more locations for customers.

While the content of the catazine will be the same, our January catazine will feature different covers depending on the customers we are targeting. Specifically the Justice customer will receive a catazine with a Justice cover whereas the Limited Too and dual shoppers will receive a catazine featuring Limited Too and Justice on the cover with the same fashion photo that is displayed on the Justice-only customer cover.

We believe our customers will respond favorably as they will understand what the transition means for them and that it is endorsed by Limited Too given its power for credibility. Our integrated approach to attracting and retaining customers will include point of sale events, continuation of our loyalty programs namely J Bucks and Fun Cards, web-based communications and the use of our direct marketing campaigns.

We realize that converting the Limited Too customers to the Justice brand is critical. What gives us the confidence in our ability to be successful is the fact that we listen closely to our customer and firmly believe that she needed us to make this shift to address her needs. We also know that despite the messages she sends to us we still have to let her know exactly what we are doing and what it means for her. So we are going to engage in the marketing campaign efforts that I just outlined and use the powerful Limited Too endorsement as much as we feel it is beneficial and necessary.

The Justice Spring apparel will be introduced in our stores on January 13 and will be representative of the entire fashion pyramid. Internal and external store signage will be changed to reflect Justice starting in January. We plan to do this at night so that no stores are closed for the signage changes. Therefore we would expect the signage conversions to be complete by the end of the first calendar quarter of 2009. Our landlords have been supportive of our plans and stand ready to facilitate the changes.

While the details are being finalized, we also plan to throw a brand launch party during the Valentine’s Day/President’s Day weekend in February. This will include a huge party in our stores featuring the message: Justice is the new Limited Too. Looks You Love for Less. We will share more details with you as we get closer to the date but we envision the use of invitations, gifts for our girls, BOGOs for our moms, models, co-branded and Justice-branded candy balloons, etc. Justice girls love parties; Tween girls love parties and we are going to do everything we can to generate excitement in the stores for the girls.

Importantly we plan to follow our traditional markdown and clearance cadence that we would typically follow. We do not plan to engage in inventory write-downs for the remaining Limited Too holiday apparel. Specifically the original Justice stores will contain Justice apparel clearance, the [inaudible] and former Limited Too stores will contain Limited Too apparel clearance, and we expect all clearance to marked out of stock in March just as we have done in previous years.

As you can see, we continue to crystallize the transition details so that we can execute the transition as seamlessly and rapidly as possible.

With that I’d like to open up the calls for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Morris - Wachovia Securities.

John Morris - Wachovia Securities

Rolando I know you’re not giving guidance on Q4, but if you could talk a little bit about the thought about the inventory plans, where you expect to finish in the fourth quarter, and would we expect the same kind of trend to continue in the spring season? And then also on the reductions to cap ex for next year, what are the components to the assumptions for spending? Does it affect your thoughts about store opening plans?

Rolando De Aguiar

In terms of the capital we have five stores on line to be opened next year and that will be the only stores that are currently on plan for next year. The remaining of the capital expenditures relates to the conversion of the signs to Justice. As far as the inventories, we continue to control our inventories very tightly. They’ll be down from where they were last year. Obviously we’re not providing guidance in terms of a Q4 number but we’re controlling them very tightly and expect to be significantly below last year.

Operator

Our next question comes from Kimberly Greenberger - Citigroup.

Kimberly Greenberger - Citigroup

I was wondering what you could comment on in terms of limiting the cash flowing out of the business as we go through 2009. Are you taking a really hard look at your SG&A structure? Obviously you’ve made some very impressive cuts to cap ex. Do you plan to manage that inventory very tightly throughout the year? What are the other levers that you can push to shore up the balance sheet?

Michael W. Rayden

To start with on the inventory side I think is a very big change coming up for us especially due to the transition. Justice as a concept runs somewhere around 25% to 30% lower inventory on an average store basis than Limited Too. So as Limited Too is brought to that structure, which it will be for our starting January deliveries, if you combine those declines in Limited Too and a mid-single-digit decline in Justice, I think you’ll find that our overall inventories as we move into the spring season could be somewhere in the range of 20% lower than historical levels. That surely provides additional cushion on the working capital side.

As you’ve seen obviously on the capital side, we’ve reduced it drastically and we really are going to run that as tight as we possibly can. We are looking at expenses on an everyday basis. It is not a one-time situation. At this point there are no further plans of major headcount reduction but everything else is up for grabs.

Kimberly Greenberger - Citigroup

My follow-up question is on the inventory. I would imagine you bought inventory for Justice assuming positive comps here in the second half of the year. Can you address the amount of the sort of over-inventory for Justice that you were able to flow through your restructuring charge?

Michael W. Rayden

We did not put any of the inventory in our restructuring charge at all. As of our latest internal forecast and clearly we have a number of them at this point, Justice looks to have a carry-over level that’s not a problem level to us at all. I will tell you that depending on the scenario, the markdowns are slightly higher but we believe that the J Bucks program accelerates our unit sell-throughs and we don’t believe that Justice will have the carry-over problem. We have many other methodologies of adjusting inventories such as sell-offs, cancellations, etc. and we’ve been working on that vein for months now, not just in the last 30 days.

Limited Too’s inventories are down at a greater level than Justice’s especially in-store and especially on the apparel side, and we have beefed up marketing and promotional activity there early in the season to hopefully sell through that inventory and move those units. Some of you may have been in stores. I think somebody has written about some testing of pricing strategies, of buy 2 get 1 free, buy 1 get 1 free, buy 1 get 1 50% off, and we will use those varying tactics in our arsenal along with the double Too Bucks and Double bonus card to eliminate our inventory selectively by store types of groups. I think we’re going to be okay on the inventory side.

The big question for us is clearly traffic and transactions. I think our business just like everybody else that’s where the effect is.

I will tell you that we’re working incredibly hard on the conversion because there’s plenty of opportunity left to service the customers who are walking in the stores and in our latest trips what we really think is happening is that the customer is postponing. They’re still going to buy for Christmas even though we think it’s difficult and I think in our company specifically they are really waiting till they can redeem their J Bucks and Too Bucks which is the greatest value proposition we offer which really just happens starting the end of next week.

Kimberly Greenberger - Citigroup

Just to clarify, you did not memo any of the Justice purchase orders over to the Limited Too division and transferring that inventory?

Michael W. Rayden

No. We haven’t done anything other than run the businesses specifically. We bought inventory for Justice. We had cut off Limited Too very early. We will start to have actually Justice’s brand new product for the January floor set in actually all stores starting the middle of December because as you know we flow our goods in. We don’t wait for an epiphany night and everything changes. We haven’t memo’d anything between divisions at all [inaudible] direct division whose business has actually been quite robust.

Operator

Our next question comes from [Tom Filnaro - FIG].

[Tom Filnaro - FIG]

Can you help us understand with the combined buy now and I guess an overall market in which specialists and retailers are cutting back significantly on buys, how that affects your IMUs going into 2009?

Michael W. Rayden

The buys don’t affect our IMUs really at all because in the combined new buys individual styles have greater quantity than they would have totally or they would have before. Our overall buy is greatly down from historical levels across all styles but each individual style is in much more depth than it would have been probably somewhere around 2.5 times.

Since they buy raw materials by style, not by overall assortment, the negotiation really is on the raw material, the piece good, the washing, the fixing and the findings. So actually our IMU in Justice go-forward versus historical Justice levels is going to be up somewhere north of 100 basis points in the spring season as we move forward.

[Tom Filnaro - FIG]

Is that on a corporate basis or is that specifically Justice?

Michael W. Rayden

It’s specifically Justice to Justice and it will be slightly down on the corporate combined basis because clearly Limited Too’s IMUs were at a higher level. But conversely Justice’s levels have been historically lower.

[Tom Filnaro - FIG]

My follow-up question is can you just update us on the webkinz business and general comments on non-apparel performance in the quarter and thoughts fort the holiday?

Michael W. Rayden

I think webkinz did about 6% of our volume in the third quarter in Justice, about 8% of our volume in Limited Too in the third quarter, and pretty close proximity on those numbers. Webkinz has been running positive comp store increases in Justice throughout the quarter and in Limited Too it was positive for the quarter even though in Limited Too in the last number of weeks it’s been slowing down and running just slightly negative comp stores while Justice’s webkinz business continues to be positive. We are planning both of those businesses down in the fourth quarter unto themselves and to the total.

[Tom Filnaro - FIG]

Anything else going on in non-apparel?

Michael W. Rayden

In non-apparel the hot things that are happening is the footwear business is actually quite good. Justice has a robust boot business; the scarf business on the accessory side has been spectacular; and the other hot category which doesn’t get a lot of glory is leg wear which is basically the tight business. I will also tell you that iCarly is good and the electronics business in Limited Too and Justice both are good, which is not the web-based business but things like messengers and MP3 players, etc. which becomes a very big portion of the business in the fourth quarter.

Operator

Our next question comes from Margaret Whitfield - Sterne, Agee & Leach.

Margaret Whitfield - Sterne, Agee & Leach

I wondered if you could comment on how your comps at the two divisions were in October versus the quarter overall and comment on how the comps break down between traffic and tickets?

Michael W. Rayden

I will tell you that October was the most difficult month of the quarter I think as it was for everybody and I will tell you that the last week of October was the worst week of the quarter. Up until that point we were probably pretty much moving along as we had expected. So everything sort of fell out where it fell out in the fourth week of October.

Our traffic and our comps are down relatively the same. We’re getting slightly higher conversion in Justice which means our transactions are not quite as down as our traffic and the same thing we believe holds true in Limited Too.

Margaret Whitfield - Sterne, Agee & Leach

And real estate costs go forward and how many stores are you planning to close next year?

Michael W. Rayden

At this point we are planning to close somewhere around 13 to 15 stores at the end of January versus our previous estimate of 26.

Margaret Whitfield - Sterne, Agee & Leach

And your real estate costs?

Michael W. Rayden

Real estate costs on the stores that we decided not to close all greatly improved and behooved us to continue to operate the stores even in this environment. Most of them went to percentage of rents that were quite advantageous to us and allows us to float with our sales.

Margaret Whitfield - Sterne, Agee & Leach

I know you commented a little bit on non-apparel. What were the comps for the two brands in non-apparel or lifestyle?

Michael W. Rayden

I don’t think we want to comment on the comps but I will tell you that the non-apparel business was better than the apparel business.

Operator

Our next question comes from Linda Tsai - MKM Partners.

Linda Tsai - MKM Partners

What are the extra costs associated with the incremental catazines and any marketing events for the next two quarters? Will there be also a higher level of marketing spend in the second half of ’09?

Michael W. Rayden

We have actually cut our circulation plans and have reduced our incremental costs in marketing for the back half of the year. So there are no incremental costs and as a matter of fact we will be saving some expense by mailing less deeply. With the five days less between Thanksgiving and Christmas, in both brands we actually eliminated a mini in Justice and we did not replace it with anything. We’re going to do point of sale and save the marketing expense. So less marketing.

In ’09 we look to save somewhere around $10 million on the media side of marketing since the duals will not be needing to be mailed two catazines, and if you remember we talked about the fact we have the opportunity to still service our best customers through our catazines but not waste the money by mailing duplicates.

We will spend less in marketing in the fourth quarter and less in marketing all through 2009 on the media side.

Linda Tsai - MKM Partners

As you bought for Justice Spring buys, assuming you bought more conservatively, what categories are you cutting back in or buying in more deeply?

Michael W. Rayden

We believe the knit top business is going to be a good business and we believe the short business is going to be a good business. We believe Bermuda’s have basically stabilized on the short short business as an opportunity and we see one of the biggest opportunities absolutely in the skirt business. I think that holds true in the entire scenario so that’s basically where the business is. It’s graphic T shirts, short shorts and skirts.

Linda Tsai - MKM Partners

And what areas have you cut back in?

Michael W. Rayden

We’ve cut back in dresses like crazy. They don’t seem to be wanting dresses at all. We’ve cut back on long active bottoms and we have cut back on outerwear and all the peripheral departments.

Operator

Our next question comes from Barbara Wyckoff - The Buckingham Research Group.

Barbara Wyckoff - The Buckingham Research Group

Outside of the marketing can you just update us on the estimate of savings say in some of the shared service areas for next year and have the numbers changed from the original projections?

Michael W. Rayden

The numbers haven’t changed really from the original projection very much. We knew where we were going to get our marketing savings, our headcount savings, and the peripheral operational savings. We are finalizing the payroll adjustments in the field that we had talked about between the co-sales leader position and the assistant position so I think that further savings will probably come in other operational areas such as being even more diligent in our travel, more diligent on everything including color copies. At this point there’s probably not a line in the business that we are not looking at.

Barbara Wyckoff - The Buckingham Research Group

Do you want to quantify that or can you at this point?

Michael W. Rayden

I don’t think I can at this point.

Operator

Our next question comes from [Rick Patel] - Merrill Lynch.

[Rick Patel] - Merrill Lynch

Can you talk a little bit about the covenant compliance for your term loan and how some of those relevant metrics tracked for the third quarter?

Rolando De Aguiar

As you know, we have two coverage, leverage and coverage, and we expect to submit covenant compliance certificates to our bank group that indicate that we are in compliance with both covenants at the end of the third quarter of this year. We are in compliance today and we believe our cash position provides us the capability to remain in compliance for the foreseeable future.

However going forward we acknowledge that there are no guarantees especially given that the consumer market that all of us are attempting to navigate today. So in the longer run it all depends on top line growth. As you should expect, we’re doing everything within reach to position our company to be successful in the seasons and years to come precisely for the reasons we made the difficult decision to transition to our single store brand Justice.

Other activities that we can directly control such as conserving cash via the reduction in cap ex and being smart about the new store leases we execute and scrutinizing all of our expenses go also a long way to that objective.

Michael W. Rayden

I don’t know whether you could hear Rolando but he said basically we’re in covenant and at this point there’s no guarantees that we’ll be in covenant, but the $61 million in cash we had at the end of the third quarter seems to provide flexibility for us to navigate the difficult waters as we go ahead and everything depends on what the consumer does in the fourth quarter and going forward from there.

We do honestly, even though it’s very difficult, expect moms and parents to buy Christmas presents for the little girls.

I’d like not to turn this conference call into doom and gloom as the world seems to be. I just think we’re trying to be prudent and avoid all these gyrations, ups and downs, and give guidance that has the caveat at the end that it could change in a nanosecond. As soon as we know what’s going on, we have a history of pre-announcing, if we get more visibility, we will give it to you folks. But at this point in time we’re operating our business as normal in difficult times.

[Rick Patel] - Merrill Lynch

Have you had discussions with your lender about altering some of those covenants or the terms of the loan?

Michael W. Rayden

Not at this time at all because there’s been no reason to have those discussions.

Operator

Our next question comes from Tracy Kogan - Credit Suisse North America.

Tracy Kogan - Credit Suisse North America

On Justice could you just talk about the performance in the quarter a little more? Are there categories at Justice that weren’t working at Limited Too and how did the mall versus non-mall Justice stores do? And lastly, is there any thought to lowering opening price points even more at Justice as you move forward? A follow up on the real estate, can you just remind us how many Limited Too stores are coming off lease over the next couple of years and what your current view is on how many of those you may close?

Michael W. Rayden

We have 590 Limited Too stores today. We’re going to close 13 to 15 stores at the end of the year. The current thought is we’ll close another 26 next year that are coming due unless we can renegotiate deals that make it more worthwhile. 26 and 15 gets you to 41 so Limited Too would have somewhere converts to Justice about 550 stores unless things change drastically at this point. However we’re looking at adding five or so and any deals that really basically work without causing any capital expenditure. So 550 or 555 is probably where the convert is Limited Too/Justice mix will be.

The rest of the questions were on opening price points on Justice. We’re pricing our opening price points as sharply as we can possibly price them. Justice has always been pretty good at that and since we have basically raised at this point our catazine coupon in Justice from 20% to 25% and expect going forward that may be the norm, price points for our core customers will be reduced across the board anyway.

What categories are doing well? These businesses are relatively the same businesses. What sells in one sells in the other with only really minor nuances. The accessory business in Limited Too because of the mall based business and the higher traffic levels traditionally is a stronger business than old Limited Too vis-à-vis the Justice. But if you look at the quarter, pretty much every component is equal: Transactions per store, average dollar sales, average store volume, etc. So not much really has changed.

Tracy Kogan - Credit Suisse North America

How about between the Justice mall versus non-mall stores? I know there aren’t a ton of them.

Michael W. Rayden

In the Justice mall stores we have a much greater transaction level than we do in the Justice non-mall stores, a slightly lower ADS which is due to a quarter of a unit being sold less than we sell off mall. The components of Justice in the mall are very similar to a Limited Too in the mall due to the higher traffic levels but most of our Justice mall stores have more households shopping than our typical Limited Too store in a mall as well.

Tracy Kogan - Credit Suisse North America

Was the performance in the quarter of the mall stores versus the non-mall stores consistent or did one perform better than the other?

Michael W. Rayden

The performance in the quarter by region, by age of opening and by everything was about as erratic as you can possibly get. The only thing that held relatively consistent and it’s not on a store-by-store basis was that the newer Justice openings are comping higher than the older Justice stores which would be normal. It pretty much goes that the oldest stores have the lowest comp and therefore up to the newest stores which have the best comp store performance.

Operator

Our next question comes from Adrienne Tennant - Friedman, Billings Ramsey & Co.

Adrienne Tennant - Friedman, Billings Ramsey & Co.

Rolando, is any of the cash in auction rates? Secondarily, on the credit facility there are some retailers that are actually proactively drawing down on that line of credit just to ensure that they have the capital to get through some tougher times. I noticed that yours I believe it was Bank of America, they’ve been one of those that has been a little bit more aggressive about pulling lines of credit. Have you seen anything or spoken with them and had any of those types of conversations?

Rolando De Aguiar

No, we have not.

Michael W. Rayden

We have no auction rate securities. We haven’t spoken to B of A at all and at this point in time we have not drawn down anything on our line and have not really even had serious discussions on doing that. All it would do would be to increase our debt which doesn’t help us in any way, shape or form.

Rolando De Aguiar

We have $61.4 million as of the end of the quarter on our balance sheet anyway.

Adrienne Tennant - Friedman, Billings Ramsey & Co.

Can you give us the November month-to-date comps just so we can look at a trend rate and maybe help us out with our own projections for the fourth quarter?

Michael W. Rayden

I don’t think we want to do comps as I said. This quarter is dependent on December which is 57% of the quarter’s sales. I think until we get to December it’s inappropriate. The quarter and the first two weeks are difficult. There’s no question about it. But there is a unique change of timing of Thanksgiving being a week later. We will lose a week of Too buck redemption in November which moves all to December.

As you all know this was the week of Thanksgiving last year which had a certain build-up and a different cadence. I think it would just be inappropriate to make pure judgments on November. I think that business will get better towards the end of November even though I don’t think it’s going to be a robust holiday.

Adrienne Tennant - Friedman, Billings Ramsey & Co.

Can you remind us if December and January comps get more difficult in terms of compares?

Michael W. Rayden

December comps were our best comp last year. For any of you who do remember we ended up having a spectacular fourth quarter last year and the best month of the season was December by far for the company.

Operator

Our next question comes from Richard E. Jaffe - Stifel Nicolaus & Company.

Richard E. Jaffe - Stifel Nicolaus & Company

Good defense guys. But looking ahead, you’ve talked about a lot of marketing initiatives for the beginning of next year with the conversion to all Justice stores. Should we anticipate additional expense related to that? Could you give us a sense of how you’ll pay for that? Obviously the game has been cutting expenses but it sounds like we might be reversing that trend at least in a small way.

Michael W. Rayden

We’re going to cut marketing expenses from this year’s absolute budget even with about 90 more stores than this year by $8 million to $10 million. That’s a fact. That’s going to happen. We do not believe that it’s the media marketing budget that’s the issue here and we do not believe we need to mail any deeper than what we’re thinking we need to mail. What we’re going to do is we’re going to use more point of sale. What you’ll see is a slightly higher markdown rate which goes along with whatever we need to do necessary to move through the units.

Richard E. Jaffe - Stifel Nicolaus & Company

The parties you talked about will be more grassroots and in-store and therefore not nearly as expensive as say national advertising?

Michael W. Rayden

We will mail into the party because the party is in the second week of February and we believe that that will be the time for the major conversion of the Limited Too girl finally wanting to be in the mall after the winter.

So the customer will get on January 13 a co-branded book that Justice is the new Limited Too. Looks You Love for Less. with a great call-out on what the differences are. They will then get a book 2.5 weeks later which is our normal cadence saying the same thing but with new fashions. Then 2.5 weeks later we will mail a jumbo postcard to a deeper portion of our file in order to invite them to the party so that they can see what all the changes are about. We have already planned that in our budget and with the $8 million to $10 million savings that number is included.

Richard E. Jaffe - Stifel Nicolaus & Company

Just a quick question on the balance sheet. Could you just review with me the assets held in trust, about $24 million, what the content and the accessibility of that is?

Rolando De Aguiar

That’s the deferred comp to rabbi trust and it’s not accessible to the company.

Operator

Our next question comes from Marni Shapiro - The Retail Tracker.

Marni Shapiro - The Retail Tracker

I’m going to try and not be doom and gloom here. I actually agree with you. I do think Christmas will happen especially for the tween girl because she’s pretty persistent and begging and there are things that are selling in your stores. I’m noticing your Peace and Love and Snoopy and Go Green. I’m seeing them more in Limited Too. I’m just seeing them for the first time recently in Justice. I’m curious if you can talk about that part of your business because it has grown from August to today pretty significantly and you’re leading your stores with it.

Then if you could also just follow up, I thought the BOGO you ran over the weekend was very compelling. I’m curious why you didn’t run it on just the apparel part of the business because it seems to me she’s buying the non-apparel anyway with maybe just the 25% off. Why did you need to run the BOGO on the non-apparel as well?

Michael W. Rayden

First of all, in the trend merchandise that you’re talking about as we would call Peace and Green and all that has been spectacular all season. That trend merchandising is obviously going to go forward in a great way in the Justice component and that happens to be a particular forte of certain talent that I have and have moved out of the Limited Too division and put into the Justice division. So that’s part of the best-of-both-worlds idea and you will see more and more of that. Justice was always a little slower on the uptake and Limited Too was always a little faster on the hottest fashion.

As for the BOGO tests, they were tests and as I will point out we tested three different pricing concepts for future use and for understanding for our future party in February which might be the best. Everything we do does not relate to something we’re going to do the following week. Again as I said we tested buy 2 get 1 free, buy 1 get 1 free, and buy 1 get one 50% off. At that point in time it is much easier for our field to not have to tell our consumers. We do already exclude Nintendo, DS lights and certain electronic products and the small print and at this point in time there’s no reason to separate some of those minor areas for us. It’s more headache for the customer than it is advantage for us on profit.

Marni Shapiro - The Retail Tracker

Just to clarify. The BOGO that I saw over the weekend was not in all stores. I just happened to hit a store that had that promotion running but a store down the street could have had a different promotion running.

Michael W. Rayden

25% of the stores, we divided the Limited Too fleet which had nothing going on this year or last year, into four groups. We tested 25% of the fleet with nothing happening; we tested 25% each with each of those BOGO opportunities and tried to ascertain what the MMU increase was or decrease was based on those tests. So dependent on which store you walked in, there could have been nothing going on or there could have been one of those tests.

Marni Shapiro - The Retail Tracker

You guys mentioned that your direct business was good. Is that true at both Justice and Too or better than your store business?

Michael W. Rayden

I think our direct business for the quarter was up over 40% and the Justice business is really starting to hum right now as we have started to market the URL in a major way both in the stores in Justice and in the catazine. The last couple of weeks in Justice have been excellent and Limited Too’s been good all season. So they seem to like the merchandise on the direct side very well. It’s the same merchandise but it’s a lot more convenient.

Operator

Our next question comes from Dana Telsey - Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

As you think about this real estate environment it’s not just tough for the retailers, it’s very tough for the developers also. What adjustments have you been able to get from real estate developers on either new or existing leases? Is there any flexibility and opportunity there? Also on your gross margin with the buying and occupancy being higher on new stores, is that going to be the case going forward and how are you managing that expense? And also any update on IMU adjustments particularly as we go into this new pricing cadence that we’re seeing from all retailers?

Michael W. Rayden

The developers are definitely more flexible than they have been probably in the last 10 years. They can’t get much more flexible. But obviously we’re all in the business to make money and we’re all in the business to partner as we go forward. As I’ve mentioned, we originally planned to close 26 stores; we’re only closing 13 to 15. That meant that with those other 11 stores we were both flexible and created a scenario where it was win-win for both situations.

The deals we have going forward are all Justice deals and those deals were good and are good or we’re not going to sign a lease because we don’t really need to grow our store base at this point. We need comp store sales. I’m finding that on every situation other than A malls everybody is very flexible on what the occupancy rates should be in this kind of economy.

So we’re seeing many more opportunities on percentage rents and I think you’ll find that everybody from our largest landlord who is Simon to the guys that have one and two centers are wanting to keep stores running and operating in their malls. This is the best opportunity for a retailer in a very long time to do the right thing. But we’re not looking to kill our landlords either because these are long-term relationships.

On the IMU side I have already said that on the Justice side of the business we’ll get more than 100 basis point improvement in what their historical IMUs would be even though we are probably going to do less business with our trading companies than we have historically since we cut our inventories back but on a per style basis they are more efficient to run because we’re buying deeper units on the styles we are buying.

I see no price pressure from overseas based on the lack of demand globally and the fuel surcharges are going to start to and are starting to improve on the shipping aspect of the business. So there doesn’t seem to be much price pressure on the cost side.

Hopefully increasing IMUs Justice to Justice, still lower than what Limited Too would have been because of the difference in retail, and on the real estate side we’re finding [inaudible] good open discussions.

Operator

Our next question comes from Howard Tubin - RBC Capital Markets.

Howard Tubin - RBC Capital Markets

Once you complete the conversion to Justice stores, do you see the mix of non-apparel versus apparel changing in any meaningful way from what it is at Justice currently?

Michael W. Rayden

Justice is a slightly higher apparel business relationship than Limited Too and I’ve said the reason before is because on the accessory side it’s slightly more dominant in Limited Too because of the foot traffic that exists in the malls and therefore the impulse shopping. As we combine the businesses you would expect that to continue as a combined business. I would guess that the penetration of apparel will go slightly lower just because of the higher penetration of accessories. And when I’m saying accessories I don’t mean just webkinz. I mean scarves, handbags, jewelry, leggings, socks, etc. I don’t see anything major.

Operator

Our next question comes from Analyst for Brian J. Tunick - J.P. Morgan Securities.

Analyst for Brian J. Tunick - J.P. Morgan Securities

Given the reduction in store openings next year, does that imply a similar flattish square footage growth in 2010? Mike, could you reiterate how many Limited Too store closures we should expect next year and also maybe in 2010?

Michael W. Rayden

We’re not even contemplating 2010. Our current numbers sort of say we’ll still open. We would look to hope the economy changes and we’re back to opening 50 to 60 stores a year in the Justice side. We still think there’s plenty of opportunity. The store closures on the Limited Too are at the end of the year. There’s about 13 to 15 and we expect to close about 25 to 26 next year.

Analyst for Brian J. Tunick - J.P. Morgan Securities

I know you’re not giving us guidance given the tough environment out there, but how does that change your previous expectation to a return to that historical operating margin of 8% to 10% over the next couple of years?

Michael W. Rayden

I think if we don’t have visibility to the fourth quarter, I would be presumptuous to think I could possibly have the crystal ball visibility going forward. I think that some of those guidances may be postponed and happen later but we do believe that the long-term opportunity still exists to get back to our historical levels over time.

Operator

Our last question comes from Kimberly Greenberger - Citigroup.

Kimberly Greenberger - Citigroup

A quick follow up. Mike, did you say the number of transactions in this third quarter was down roughly 5% to 6% and the average dollar value of the sale was down 5% to 6%?

Michael W. Rayden

No. The transactions were down a much greater number than that. They were down in the low teens in both brands. So the big issue here was really transactions.

Kimberly Greenberger - Citigroup

Then we can just plug the average dollar sale for the balance to get the total comp?

Michael W. Rayden

The average dollar sale was relatively flat in both brands to slightly up actually so the size of the sale is good. The units per transaction is good. There’s just not a lot of traffic and not a lot of transactions.

Operator

I would now like to turn the floor back over to management for closing comments.

Julie Sloat

Thanks for joining us today. This is Julie Sloat. I’ll be available for any follow-up questions and Rob, if you could give us the replay instructions, that’d be fantastic.

Operator

Ladies and Gentlemen, a replay of this call will be available approximately one to two hours after the conference has ended. To access the replay you may dial 1-277-660-6853 and enter account number 286 when prompted. Your replay ID number will be 301113.

Ladies and Gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time.

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