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Ann Taylor Stores Corporation (NYSE:ANN)

Q3 2008 Earnings Call

November 21, 2008 8:30 am ET

Executives

Maria Sceppaguercio- Senior Vice President of Finance, Communications & Investor Relations

Katherine Lawther Krill – President and Chief Executive Officer

Michael J. Nicholson – Chief Financial Officer

Analysts

Kimberly Greenberger - Citigroup

Tracy Kogan - Credit Suisse

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

Liz Dunn - Thomas Weisel Partners

Dana Cohen - Banc of America Securities

Robin Murchison - Suntrust Robinson Humphrey

Roxanne Meyer - UBS

Barbara Wyckoff - Buckingham Research Group

Michelle Tan - Goldman Sachs

Jeff Black - Barclays Capital

Brian Tunick - J.P. Morgan

Lorraine Maikis - Merrill Lynch

Operator

Good morning ladies and gentlemen and welcome to Ann Taylor Stores Corporation third quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Maria Sceppaguercio, Senior Vice President of Finance, Communications, and Investor Relations. Please go ahead.

Maria Sceppaguercio

Thank you and good morning everyone. Here with me today to discuss our results is Ann Taylor President and CEO Kay Krill and our Chief Financial Officer Mike Nicholson. As you know, earlier this morning we issued our results for the third quarter of fiscal 2008. As indicated in our release, we recorded breakeven results on a diluted EPS basis, excluding restructuring charges. This compares with EPS on the same basis of $0.67 last year.

In terms of our share repurchase activity for the quarter, as we stated in our release on November 6 we did not repurchase any shares during the third quarter in keeping with our objective to preserve cash in this uncertain environment.

Before I turn the call over to Kay I would like to remind you that our discussion this morning includes forward-looking statements which are subject to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the company’s current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company’s filings with the SEC. With that I will hand it over to Kay.

Katherine Lawther Krill

Good morning and thank you for joining us today. Let me open up my remarks this morning by first acknowledging the unprecedented nature of today’s economic and consumer environment. Clearly the effects have been deep and far ranging. Many months before the nation officially entered a recession, the retail sector was experiencing recessionary conditions and in light of the slowdown in consumer spending Ann Taylor moved proactively to protect our strong balance sheet, reduce our cost structure, manage inventory levels and insure that we were appropriately sized and well positioned for what we believed would be a challenging macroeconomic climate.

With current economic forecasts calling for recessionary conditions to persist throughout much of 2009, it is clearly more important than ever to maintain a healthy balance sheet and strong liquidity position. In this regard, we are very well positioned. We closed the quarter with more than $80 million in cash and we have no debt. In fact, our cash balance has grown since quarter end and we are very comfortable with our liquidity position.

Earlier this year as we started to restructure our company’s operations, cut back on capital plan and delay indefinitely plans for a new retail concept, all of which we announced last January, we did not envision the kind of downturn we are now experiencing. In fact, it is remarkable how well we managed through the softening environment in the first half of this year, and we made significant progress on our restructuring program. But as you know, during the latter part of the third quarter the economic situation and consumer confidence took a dramatic turn for the worse.

As a result, we recently took additional more dramatic steps in order to preserve cash and keep our balance sheet strong so that we could deal with the current and near term economic crisis. Specifically, we moved very aggressively to expand our restructuring effort already under way and we took decisive action to insure our organization is structured and sized for what may be a prolonged recessionary environment.

I am convinced that the steps we are taking to reduce our cost structure and implement a strategy that is designed to protect the foundation of our business and our brand will not only enable us to continue to manage successfully through this downturn, but will also position us to emerge as the more nimble, efficient and effective organization, well positioned for growth when the economy turns. With that as a backdrop, let me turn to our results for the quarter and a discussion of each of our businesses.

In line with what we announced a couple of weeks ago, we reported breakeven EPS for the quarter, excluding restructuring charges. These results reflected a very soft top line and gross margin weakness, primarily reflecting aggressive promotional activity to move through inventories. We purchased inventory for the quarter quite conservatively on expectations of a negative mid-single digit comp decline.

As it turned out, sales were much weaker particularly in the last several weeks of the third quarter. We aggressively cleared through much of our inventory and finished the quarter with total inventory on a per square foot basis down 10% versus last year.

Looking ahead to the fourth quarter, we expect these very soft sales trends to continue. As a result, because we bought inventory to the expectation of a mid-single digit comp decline, we expect gross margin to continue to be under significant pressure. Turning to SG&A we have been very focused on tightly managing all of our expenses and accelerating wherever possible restructuring initiatives already underway. This focus on reducing costs resulted in a $12 million decline in SG&A in the quarter, despite a 5% increase in our store base. And we continue to aggressively go after cost reduction opportunities.

Two weeks ago, we announced acceleration and expansion of our three year strategic restructuring program which we now expect to result in savings in the range of $80 to

$90 million. Mike will take you through the details of our restructuring program in a few minutes, but let me touch on one strategic aspect of the program related to our organizational structure that we expect will improve our efficiency and effectiveness moving forward.

Specifically, after careful consideration regarding the optimal structure for our company, we have transferred responsibility for certain functions previously led at the corporate level to the division, given the strong leadership now in place at the brands. During these difficult times and with two new brand presidents, I will be spending a significant time of my time with our new divisional leadership on all aspects of our business that touch on our clients; namely product, marketing and the in store experience. We expect this change to increase speed, efficiency, and effectiveness across the company.

Turning now to the divisions starting with Ann Taylor, the third quarter was a particularly difficult one for this division with comp store sales down 25% and margins very soft. Clearly this performance is disappointing to all of us. We believe there are three factors impacting Ann Taylor right now; first, the overall deterioration in the macroeconomic environment is clearly impacting the women’s apparel sector more than most and our traffic and DCT’s were soft as a result.

Second, and related to the overall economic situation, is the significant impact the financial crisis is having on the professional working woman. This particular demographic represents the Ann Taylor client. In addition, corporate headcount reductions and rising fears of future unemployment have made our client cut down or even cut out her spending all together. This is evident with the dramatic pullback in demand for wear to work separates and suits, which represents about a third of our assortment as our client is just not investing right now in these categories.

Finally and very importantly, we lack the product relevancy and versatility our client is looking for right now, particularly in our tops category which represents a significant percent of our business. As a result of these three factors, we were over-inventoried during the quarter which required us to be highly promotional to keep our inventory turning, which we did effectively. As we enter the fourth quarter, the Ann Taylor division will continue to be promotionally aggressive as we don’t expect improvement in the macroeconomic or competitive environments in the months ahead.

Our product assortment for fourth quarter, which is focused on special occasion for November and gifts for December is likely to be under pressure as our client appears not to be investing in special occasion this year and is likely to cut back on gift purchases as well. We have, however, seen encouraging early results in our cashmere assortment. You may have seen that our cashmere was recently recognized as the best cashmere on the market in a blind test by In Style Magazine.

This is an important point about our technical quality. It remains very high and there is an opportunity for us to build on that in our marketing to the client. Our cashmere assortment will help anchor our holiday gifting assortment heading into Thanksgiving and December.

As we look ahead to 2009, we are positioning the business defensively with a very conservative inventory receipt plan. We are also making progress behind the scenes to reposition and rejuvenate the brand and you will begin to see the results of this work in fall 2009. Let me spend a moment providing some insight into the progress we have made and why we believe the plan will be successful.

First, we have established a new team at the division to reposition the brand. Christine Beauchamp, the new Ann Taylor President, has assembled a team of best in class retail leaders comprised of a combination of internal and external talent with excellent track records of success. Critical positions recently filled include the Head of Design, a new GMM, and a new Director of Stores among others.

Second, we are re-architechting the assortment for profitability. That means we are building a core assortment that will provide a stable profitable base to the assortment. This will enable loyal clients to repeat purchase their favorite styles in multiple colors and fabrics. We are also further reducing our SKU count and will focus on a balance of key items and fashion units.

In addition, we will continue to buy inventories conservatively. Together, all of these initiatives are expected to drive increased margins and improve profitability at the division over the longer term. And finally, we are returning to our heritage and focusing on making Ann Taylor a style destination again for what is chic, sophisticated, feminine, and relevant now; a cosmopolitan point of view anchored in modern versatile separates, tops, dresses, and accessories. In addition, Ann Taylor has always represented great quality and we will focus on doing a better job to market the value we have to offer.

One of the important differentiators in the market for Ann Taylor is that our clients continue to have a positive affinity for the brand, and we continue to be viewed as an icon within our sector. This brand strength is a tremendous asset. We recognize that we must continue to evolve in keeping with the changing needs and preferences of our clients, and that’s where our focus is. I am very optimistic about the vision for Ann Taylor and the direction the new team is headed.

Now turning to Loft, our top line at Loft was also under pressure. We believe that this pressure was the direct result of the soft economic and consumer environment. We believe Loft’s value proposition positions the brand relatively well in this environment. Soft traffic, a highly competitive promotional environment, and our focus on moving through inventory during the quarter led to our negative 15 comp and very soft gross margin.

In terms of third quarter product, I believe our assortment was much better than the previous quarter. Our best performing categories were sweaters, dresses, denim, and other casual bottoms. Categories that were weaker during the quarter included refined separates, shoes, handbags, and jewelry.

Looking ahead to the fourth quarter product, I feel good about our upcoming assortments which are fresh, fun, and exciting and fully express the design and direction of the new Loft design team. However, despite good product we expect environment to put pressure on the top line.

Finally, I am very pleased and excited that Gary Muto has joined us last week as President of our Loft division. This appointment completes my senior management team and was a critical hire for us in enabling the divisionalization of the business. Gary is a seasoned executive and brings to Loft not only his knowledge and extensive experience but a lot of dynamic, positive energy as well. The team here is very excited and we look forward to maximizing the potential of Loft in the years ahead under Gary’s leadership.

Now turning to Factory, the soft macro environment has taken its toll on this channel as well, with traffic down significantly and other in-store metrics under pressure during the quarter. However, the Factory division did a good job maximizing gross margin throughout the quarter. Loft Outlet which was first launched in July with the opening of 10 stores is meeting our expectations. We launched four additional Loft Outlet stores since July and we see a good deal of growth potential in this business. We will continue to invest conservatively in this concept.

Finally growth in our Internet business which has been experiencing double-digit revenue growth over the last several quarters began to slow a bit as the economic crisis deepened in the third quarter. Nevertheless, sales growth remained in the high single digits and we continue to view Internet as a highly scaleable and cost effective growth channel. Moreover, it serves as a critical marketing tool that enables immediate and cost effective outreach and drives incremental traffic to the stores.

With that, I’d like to turn it over to Mike who will take you through the financial details of the quarter and our outlook for the balance of the year.

Michael J. Nicholson

Thanks Kay and good morning everyone. Before I jump into our third quarter results, I’d like to spend a few moments on what I believe matters most from a financial perspective in the current environment, starting with cash which as you know right now is king. We have a very strong balance sheet, no debt, a solid cash position, and access to a $250 million revolver. This revolver is a committed facility available through 2013 with a strong and diversified consortium of banks headed by Bank of America, J.P. Morgan, and Wells Fargo.

As you know, this is a new facility that we entered into in April of this year. It has no financial covenants provided our total available liquidity remains above $37.5 million. In addition to our strong balance sheet, we generate more than enough cash to run the business. In addition, we are committed to our very conservative approach to discretionary cash expenditures like capital for instance. We expect spending to be less than $60 million, a reduction of more than 50% versus this year in 2009.

In addition, while we clearly believe that our stock is a value right now, we are taking a very conservative approach to buybacks. As you know, we did not repurchase any stock in the third quarter. We also took a very conservative approach to our inventory receipt plan for spring 2009. In fact, we bought spring receipts to the current trend of the business.

Furthermore, we do not have to make product commitments for the second half of 2009 until early February and this will give us the opportunity to read the fourth quarter selling period and more importantly have better insight into the mindset of consumers before we commit. This conservative receipt plan conserves cash and positions us for better margin performance as we move from the fourth quarter of 2008 into 2009.

Finally, we have been very aggressive with our cost reduction initiatives and we’ve just ramped up our efforts even further to dry significantly more savings than previously planned. So aside from the critical activities surrounding strengthening our brands which Kay discussed earlier, we are being extremely aggressive in managing all controllable elements of the business.

Turning now to our third quarter results, starting with sales net sales declined 12.3% versus year ago to $527 million reflecting our overall comp decline of 19.4%. By division, net sales at Ann Taylor declined 25% to $159.5 million in line with its comp performance. At Loft, net sales declined 11% to $263 million on a comp store decline of 15.4%. Gross margin for the quarter declined 730 basis points to 48.8% versus 56.1% last year. This performance primarily reflected the impact of the soft top line and aggressive promotional activity to clear through inventory.

Total inventory for the quarter declined 10% versus year ago, reflecting a total in-store inventory decline of 13% partially offset by in transit inventory that was essentially even with year ago. As we mentioned previously, this in transit inventory will put pressure on Q4 gross margin as we bought to a much better comp than we now anticipate.

Our SG&A for the quarter was down 4% or approximately $12 million to $258 million. This improvement reflected lower store occupancy and payroll costs at existing stores, restructuring program savings and tight management of expenses, as well as reduced performance based compensation expense. Partially offsetting these benefits were operating costs associated with new stores and planned investments supporting the launch of Loft Outlet.

We are pleased that as expected, we are seeing the benefits of our restructuring initiatives in our financial results and in fact, savings are now trending ahead of our original expectations. In terms of restructuring details for the quarter, pretax charges totaled $19.9 million. On an after tax basis, charges totaled $13.2 million or $0.24 per diluted share. In the third quarter last year, we incurred $1.3 million in pretax restructuring costs which amounted to $800,000 on an after tax basis or approximately $0.01 per diluted share.

Excluding these restructuring costs, operating income in the quarter was approximately breakeven compared with $67.9 million last year. Net income on the same basis was also approximately breakeven compared with the net income of $41.5 million or $0.67 per diluted share in the third quarter of 2007. Weighted average diluted shares outstanding for the quarter declined 8.6% to 56.3 million shares versus 61.5 million shares in the third quarter of last year.

Our effective tax rate was 33.6% for the quarter versus 39.5% last year. Depreciation and amortization in the third quarter totaled about $33 million versus $30 million last year. Capital expenditures for the third quarter were down 45% versus year ago to $28 million versus

$51 million in the third quarter of last year. Our total store square footage at the end of the third quarter totaled approximately 5.7 million square feet, a 5.2% increase versus the 5.4 million square feet at the end of the third quarter 2007.

During the third quarter, we opened 15 new stores and closed 8 ending the quarter with 966 stores. The Loft division opened 8 stores and closed 7. Ann Taylor Factory opened 5 new stores and Loft Outlet opened 2 new stores. We did not open any Ann Taylor stores and closed 1 during the quarter.

Turning now to our strategic restructuring program, as you know a couple of weeks ago we announced the expansion and acceleration of our existing three year restructuring program, which is now expected to generate ongoing annualized savings of $80 to $90 million, up from our previous expectations for $50 million in savings. We expect to generate $35 million of these savings in fiscal 2008 or $10 to $15 million more than our previous expectations for $20 to

$25 million.

This increase in expected savings for this year reflects the benefit in 2008 of approximately

$6 million from our workforce reduction recently announced, as well as additional savings from initiatives in our stores and in the procurement area. Costs associated with the overall program are now expected to be in the range of $65 to $70 million over the three year period.

These costs include the $40 to $45 million originally anticipated under the January program plus incremental costs of approximately $12 million associated with the workforce reduction announced on November 6, as well as charges totaling approximately $12 million related to the additional non-cash write down of assets associated with our original store closure plan. And we expect to incur approximately $30 million of these costs in fiscal 2008.

You will recall the key element of our restructuring program involves optimizing our store portfolio. For 2008, we plan to close about 60 stores under the program with 33 Ann Taylor stores closing and 27 Loft stores closing. To date, we’ve closed 26 stores, 9 of which were Ann Taylor stores and 17 of which were Loft stores. And we expect to close the remaining 34 stores during the fourth quarter with a majority of these stores closing at the very end of the fiscal year.

Turning to the P&L impact of our restructuring for the third quarter, we incurred approximately $19.9 million in pretax restructuring costs comprised of $12.2 million in cash charges primarily related to severance associated with the company’s organizational streamlining that we announced earlier this month, and $7.7 million in non-cash charges related to the additional write down of assets associated with our planned store closures.

In the third quarter of last year we incurred $1.3 million in cash charges related to consulting services to support the launch of the program. For the first nine months of 2008, total pretax restructuring program costs totaled $26.8 million in 2008 versus $2.2 million in 2007.

Moving on now to our viewpoint on the balance of the year, while we’re not providing specific EPS guidance I do want to share with you how we are currently thinking about the fourth quarter and the full year. Starting with the top line, we are planning for comps to continue to be under the pressure we experienced in October and into early November, specifically in the down 25% range overall. While we’re hopeful the trends will pick up, we’re not counting on it.

Since we bought inventory to a mid single digit comp decline, this much softer top line expectation along with a very competitive and promotional environment, and our focus on ending the year in a healthy inventory position, will put significant pressure on gross margin as it did in the third quarter. We expect SG&A to continue to show improvement, although on a rate basis it will be under significant pressure.

And finally, we expect to end the year with cash in the range of $75 to $100 million. And with that, I’ll turn it back to Kay.

Katherine Lawther Krill

Thanks Mike. Before we go to your questions, I’d like to leave you with these thoughts. First and most importantly, our company is financially strong. We have plenty of liquidity including a solid cash position and access to an additional $250 million committed revolver that is available to us through April 2013. I am highly confident that we will successfully manage through this environment.

Supporting our ongoing fiscal strength is our aggressive restructuring plan. Our actions over the past several quarters clearly demonstrate that we will act decisively to protect our business and position the company for success when the economy improves. The important restructuring actions we have taken to date are already generating better than expected results and they pave the way for significant additional benefits over the next two years. As you know, success in this business starts with having good products that resonate in the marketplace.

Loft’s product is better and I am confident that it will continue to improve under Gary’s leadership. For Ann Taylor, we know we have work to do but we believe in our vision and strategy and are confident that Christine and the new team will be successful. My senior leadership team is now complete and we are operating with a leaner, more efficient organization that is highly focused on achieving success.

And finally, you should know that we are approaching 2009 very realistically. That means we are reducing costs across the business and conserving cash through tight inventory buys, a dramatic reduction in capital spending, and a very conservative stock repurchase stance. These actions will insure that we have the cash flow and liquidity to run the business during these difficult times and position our brands for success when the economy improves. With that, let’s open it up to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kimberly Greenberger – Citigroup.

Kimberly Greenberger – Citigroup

Mike forgive me if I missed this, but did you give specific inventory guidance for the end of the fourth quarter this year?

Michael J. Nicholson

Kimberly we did not provide specific guidance, just a quickly recap in terms of where we landed for the third quarter at a total company level. Total inventory was down 10%. Our in-store inventory was down 13%. When I look at the inventory by business unit, Ann Taylor in total was down 15; in-store inventory was down 22% and then from a composition perspective our carryover inventory at Ann year on year in-store was actually down 30%.

At Loft our total in-store inventory was down 14%, at the total division level down 12 and again from a composition perspective carryover, it was down 20%. What I will say is that we are planning to aggressively move through our receipts during the fourth quarter and position us quite frankly in even better position than we are today, moving into the first quarter of next year.

Kimberly Greenberger – Citigroup

So it sounds like you were able to be very proactive with your spring deliveries. Did you have a better opportunity to cut the first quarter of deliveries or the second quarter? And when you say you’re buying inventory for spring in line with current sales trends, would that be in line with the comp trend in the third quarter of sort of in line with the weaker trends that you saw in September and October?

Michael J. Nicholson

In terms of first quarter, second quarter we were successful in affecting both the receipt plan for both the first quarter and the second quarter. And in terms of the trend that we’re buying to, we were able to successfully execute a receipt plan to support the trend that we experienced in the back half of October. And again from a comp perspective as I think about the trend of the business and the comp store performance, beginning of quarter to end of quarter, I sort of think about it in terms of 5 comp points to the plus and minus side. Just to give you a perspective to the degree that we’re buying spring.

Katherine Lawther Krill

Also Kimberly we had left money open for the first quarter so we were able to affect that with absolutely no liability. And we just bought second quarter a few weeks ago, and we have not yet bought the back half of the year and will not be buying third quarter until the beginning of February. So we feel like we’re going to be able to read the consumer mindset through the fourth quarter and be a lot smarter as we go into the back part of the year.

Operator

Your next question comes from Tracy Kogan - Credit Suisse.

Tracy Kogan - Credit Suisse

I was hoping you could break down that $60 million in CapEx you expected for next year between new stores, refreshes and IT and other. And then secondly, I was hoping you could talk a little more about your landlord negotiations for the stores that you’re closing and whether you’ve changed your view on the ultimate number of stores you think you’ll close, based on maybe getting better deals from the landlords. Thank you.

Michael J. Nicholson

Sure. A couple things, in terms of the CapEx for 2009 the $60 million, new stores plus store maintenance capital in the range of $25 to $30 million with the balance coming out of the area of IT. In terms of our ongoing store closure program, we are still clearly on target to deliver the 117 store closures. And there will likely be other store closures that will fall out as part of the natural business closure process.

Tracy Kogan - Credit Suisse

But you haven’t found that the landlords have been able to negotiate with you to the degree that you’d actually want to keep some of those stores open?

Michael J. Nicholson

Well, where there are instances where we are successfully able to negotiate costs out of the box, if you will, we absolutely would reconsider maintaining that location. And with every location, it is sort of a case by case, store by store negotiation.

Operator

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

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

About this paradigm shift of kind of the working woman and I expect that to persist, you know, well beyond ’09, and maybe it’s a permanent shift so when you look into spring you’re suiting business, what are you shifting that product into? Thank you.

Katherine Lawther Krill

You know what, Adrienne? I’m sorry. The beginning of your question we did not hear it. You kind of phased in in the middle. Could you repeat it please?

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

Okay. Sorry about that. I was talking about kind of the paradigm shift that you spoke about in your prepared remarks, about kind of the working woman and the shift away from this more professional, maybe suiting, and the fact that, you know, it’s likely that that type of trend persists longer into ’09. And maybe it’s in fact a permanent shift. So when you look at spring, what have you replaced kind of that suiting business with, if you down trended it? And how do you look at that replacement of that business at the Ann Taylor stores division go forward, since it has been such a big part of the business?

Katherine Lawther Krill

I think that definitely we have seen this starting to occur mainly in the second quarter into the third quarter, so it’s definitely – we have planned it down for all of the first half of the year appropriately. And what we’re really investing in as you can imagine, the tops penetration just continues to go up and up and up. Because that’s really what women are doing today, is buying new tops to perk up their wardrobe. So that’s what we’re focusing on right now. We’re also focusing on more versatile and relevant separates for what she wants today.

I think it’s a different day and definitely she’s not interested in suits. I think that women want their wardrobe to work harder for them. They want it to be able to go to work and on the weekend and that’s what we’re seeing happening. The dress business, however, is still relatively strong at Ann Taylor as it was one of the bright spots of the third quarter and we continue that to be good.

What we’re trying to do is really revitalize the entire assortment at Ann Taylor and better balance the product offering by end use as well as balance the key items with fashion, which has really not been as much of a focus. And that’s definitely a focus for Christine and the team. I really feel like it’s a new day at Ann and the entire division is very optimistic about the future and really modernizing this great division.

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

Does it make it more difficult to be on a go forward basis to keep Loft and I know it’s much more casual, but to keep Loft and the stores very differentiated from one another?

Katherine Lawther Krill

Absolutely. I think they’ll be even more differentiated because Loft’s positioning is really sound. We feel like they look really good right now and its feminine casual is really the handle. And I feel like they are very well positioned. The price points are positioned well. There’s a tremendous value inherent in that product. And I think the Ann division is where we needed to rejuvenate and revitalize and really re-architect the assortment for profitability. So that’s what we’re doing.

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

And Mike one last question on the SG&A dollars in the fourth quarter, it looks like in the third quarter you were able to – you were looking at positive low single-digit dollar growth earlier and you were really able to impact that, so given the changes you’ve just made should we expect dollar growth in SG&A to be down more than the 4%? Thank you.

Michael J. Nicholson

Actually in terms of dollars year on year, the dollar change year on year Q3 I would expect order of magnitude to realize a similar benefit in the fourth quarter of ’08 as compared to ’07.

Operator

Your next question comes from Liz Dunn - Thomas Weisel Partners.

Liz Dunn - Thomas Weisel Partners

I guess my question relates to the restructuring. Can you just talk a little bit more? I think at this point you’ve laid off or let go about 30% of your corporate headcount. What functional areas were hit hardest? And is there any risk that, you know, you’re running too lean or cutting into the muscle at all? You know, how’s morale? How are you keeping people motivated there, given that, I’m assuming, there’s no bonus this year and 30% of their colleagues are gone? If you could just talk about all those dynamics please.

Katherine Lawther Krill

Liz, we really approached this across all functions. There was not one function that was hit harder. Well, the Ann Taylor division was probably hit the hardest. But we really focused on layers and span of control and really ramped up that span of control. So we feel like as we’ve had – I mean, this has just been two weeks, but we feel like we have not cut into the muscle. And we have not – we do not feel like we’re too lean.

We have not heard any issues regarding it in the past couple of weeks, and we feel like we’re going to definitely operate more efficiently and more effectively, given the fact that we have less people especially in the product parts of the business which were probably hit the hardest. We did a lot of benchmarking with other companies of similar styles and SKUs and felt like we were definitely bloated in that area. And we right sized those product teams for the environment today. So we feel good about that.

As far as what I’m trying to do to keep morale up is I feel like the new leadership that has really joined the company is doing a fantastic job of re-energizing definitely both divisions, the morale is definitely better in both, actually all divisions. And they’re communicating often, they’re having town halls, I’m communicating often via email, via phone, video across the world, pulling the senior leaders together.

We are definitely over-communicating, which I think you have got to do in this kind of environment, to keep the associates abreast of what’s going on, to let them know that we’re financially strong, and let them know that we have a bright future when the economy improves.

Operator

Your next question comes from Dana Cohen - Banc of America Securities.

Dana Cohen - Banc of America Securities

Going back to the SG&A, just walk me through again the gross savings for ’08 and the net savings for ’08 and the same for ’09. So you achieved $35 for ’08. Is that gross or net?

Katherine Lawther Krill

Dana, let me just take that. The $35 million that you’re referring to are SG&A savings. They’re ongoing annualized. Just savings. It is not net of costs.

Dana Cohen - Banc of America Securities

I’m not talking restructuring costs. I’m talking the – you know, there were some expenses for Factory. There were other like growth initiatives. So when we look to how much you’re net pulling out of other initiatives, is $35 the net number you’re pulling out of the cost basis or the SG&A basis of the business? Forget about restructuring charges. I’m saying net of other initiatives that cost money.

Michael J. Nicholson

The $35 million is a gross number associated with the restructuring initiative in 2008. There are other puts and takes against that. For example, the investment in Loft Outlet, we’ve got ins and outs with performance based compensation. I’d be happy to after the call sort of walk you through the third quarter and year-to-date activity if you’d like.

Dana Cohen - Banc of America Securities

Okay. And then the $80 to $90 is the sequential increase – or is the total number, so take $35 from the $80 –

Michael J. Nicholson

It’s the total cumulative number over the three year period.

Dana Cohen - Banc of America Securities

Over a three year period.

Katherine Lawther Krill

$35 of which we realized in 2008, the balance of which is spread over the next two years with a big chunk of it in 2009 and the balance in 2010.

Dana Cohen - Banc of America Securities

So what should we be thinking SG&A dollars would be down in ’09?

Michael J. Nicholson

I don’t think we’re in a position today to provide guidance – specific guidance on SG&A. We’ll be happy to conversation in early March.

Dana Cohen - Banc of America Securities

And then just I’m not sure I quite caught it, but Loft inventories can just give again the total in-store and carryover numbers?

Michael J. Nicholson

Absolutely. So Loft in total at the end of the third quarter was down 12% on a dollars per square foot basis; in-store down 14% and from a carryover perspective, year on year, down nearly 20%.

Dana Cohen - Banc of America Securities

And the Ann total in-store is down 15 –

Michael J. Nicholson

Ann total, Ann excluding the impact of beauty was down 15%, in-store down 22% and in terms of carryover into the fourth quarter year on year down 30%.

Dana Cohen - Banc of America Securities

And what is it with beauty?

Michael J. Nicholson

Its 18 – in-store 18 versus 22, so about a 4% impact including the impact of beauty.

Dana Cohen - Banc of America Securities

And then just one other question, do you think inventories will be totally in line by the end of the fourth quarter or do you think it takes until the end of the first?

Michael J. Nicholson

Our inventories will absolutely be in line as we move into 2009.

Operator

Your next question comes from Robin Murchison - Suntrust Robinson Humphrey.

Robin Murchison - Suntrust Robinson Humphrey

I wanted to ask about product costs and third party brand performance by division. Thank you very much.

Katherine Lawther Krill

I’m sorry, can you repeat the question? I’m sorry, I didn’t hear - we didn’t hear you.

Robin Murchison - Suntrust Robinson Humphrey

Right. What’s going on with product costs and then third party brand performance by division?

Michael J. Nicholson

I mean, I’m happy to take the product cost component of the question. You know, candidly earlier this year we were anticipating pressure on costs and pressure on IMU heading into 2009. But candidly, given the macro environment that’s impacted the world, we are actually not seeing any pressure on costs and to some degree we will aggressively go after cost reduction and working with our strategic supply base going forward.

Katherine Lawther Krill

And as far as third quarter brands, it is a very insignificant part of the business in both divisions actually, primarily dresses at Ann Taylor and they did very well. And primarily fashion tops in Loft and those did well, too. So it’s very – it’s probably less than 3% of the assortment in both brands but they were okay.

Operator

Your next question comes from Roxanne Meyer – UBS.

Roxanne Meyer – UBS

I was just looking for a little more color on your new strategy – merchandise strategy at Ann Taylor. In your prepared remarks you talked about re-looking at the mix and SKU reductions and I’m just wondering if you could give us a little more detail as to, you know, what that means, how the mix is going to be comprised, where you’re going to remove some SKUs and just based on your new skewing towards more fashionable looks. Who do you consider to be your sweet spot in terms of your competition and how that can change? Thanks.

Katherine Lawther Krill

I don’t want to get into the specifics of the mix right now, but what we are doing is we are protecting the assortment for profitability to better balance key items with fashion, which we feel like we did not do a good enough job before. And also to continue to reduce SKUs in this division. We took one stab at it going into the back half of this year. We further reduced the styles and SKUs going into ’09. We’ve reduced store sets.

We’re trying to build more of a base to the business, a foundation of styles that we’re calling The Perfect Pieces that will last from quarter to quarter and build the fashion and the key items on top of that. We feel like that’s the way to go. The other thing is that we’re really returning to our heritage to try to be the style based destination in Ann Taylor for what is modern and relevant for the working woman today.

I think it’s very different today than it was a year or two years ago and this is a work in progress and we feel like we’ve made a lot of good progress going into fall ’09 on this initiative. And good progress in reducing some SKUs in spring and summer ’09, but we really feel like the back half of the year will more fully reflect where we’re going with this division with the new design team.

Operator

Your next question comes from Barbara Wyckoff - Buckingham Research Group.

Barbara Wyckoff - Buckingham Research Group

In the restructuring efforts, have you combined merchandising support areas between divisions like technical and production or responsibilities still [siloed] by division? And then secondly, do you have separate design and merchandising organizations for the four divisions meaning Ann, Loft, Factory, and Outlet or do you run the Outlet, Factory business as an adjunct to the core brand?

Katherine Lawther Krill

Okay Barbara. As far as we do – sourcing is definitely divisionalized; we have separate teams for the Factory and Ann and Loft but they report into the chief supply chain officers as well as the technical function. As far as design teams, Ann has their own design team and Loft has their own design team and the Outlet - the Factory and Outlet businesses basically is a best seller business from the brand, so they do not have design functions.

Barbara Wyckoff - Buckingham Research Group

And then just one last follow-up, I mean honestly Ann has been – Ann Taylor Stores has been struggling for a long time to get a more modern and relevant assortment, so you know I’m hearing the same thing over again. You know, Kay, what gives you the confidence that this will work? I mean, this has been a long time so you know what is different than before?

Katherine Lawther Krill

What is different is new leadership and new design talent. That is what is different. As you know, Barbara, we have been – we’ve had a design opening since last January in the Ann Taylor division and we have just hired someone that I have wanted for a very long time. She is fantastic. She just started. Christine is the new President of the division. She’s been able to assemble, I think, an unbelievable team in very short order that will turn this business around and rejuvenate it and modernize it and really do it.

We have been talking about it, but I think that it requires a fresh eye and really more objectivity with a new team that is going to get behind it and make it happen. I am very confident that this team is going to make it happen because they’ve already made a tremendous amount of progress.

Operator

Your next question comes from Michelle Tan - Goldman Sachs.

Michelle Tan - Goldman Sachs

I was wondering if you could give us a little more color on the difference between the total inventory per foot and what you are calling out at the divisions. It seems like still a big gap to just be represented by Loft Outlet. So what’s in that spread?

Michael J. Nicholson

I’m sorry. Can you clarify? It’s Mike.

Michelle Tan - Goldman Sachs

Yes. So you said in the release that the inventory per foot in total is down 10%. Right? If you look at the individual divisions at Ann Taylor you’ve got inventory per foot down 18% including beauty, right? And inventory at Loft down around 14% or 15%. So you know what else is in there that’s?

Michael J. Nicholson

There’s a couple of drivers. Within those business units, it’s the impact of in transit year on year as well as to your point, the incremental inventory in the current year period to support the launch of Loft Outlet as well as incremental inventory in the current year to support the Internet business.

Michelle Tan - Goldman Sachs

Can you give us a sense of how big those things are? And so in transit is included in the total inventory per foot?

Michael J. Nicholson

Correct.

Michelle Tan - Goldman Sachs

How big – do you know roughly how big the in transit number is?

Michael J. Nicholson

We don’t provide a specific guidance on that.

Operator

Your next question comes from Jeff Black - Barclays Capital.

Jeff Black - Barclays Capital

Hey, Mike, pardon me if I missed it but can you outline or just remind us of what the cost component of the restructuring program is for ’09? And did you give us an operating cash number? And if not, could you? Thanks.

Michael J. Nicholson

For 2009, Jeff?

Jeff Black - Barclays Capital

Well, no, for the quarter. The operating cash number and then the cost component of the program, you know. Are we to assume there’s another $30 million in cost for ’09 for?

Michael J. Nicholson

Yes. Yes. Okay so just real quick in terms of the total program, we are looking at total program costs in the range of $65 to $70 million. As you know in 2007, we recorded approximately $32 million worth of costs. In 2008 we’re anticipating about $30 million of costs in total. So we’re left with $5 to $10 to go. As it relates to the way we’re thinking about the current program.

Jeff Black - Barclays Capital

And Mike are you thinking you cut into the store base more? Is there another leg of this you might pursue?

Michael J. Nicholson

Yes. I’d say a couple things, Jeff. You know, clearly the environment as it relates to the landlords has changed dramatically in the last six months. So you know we obviously take that into account going forward, assessing not only the current performance of our business but also how we’re thinking about the performance prospectively. Also taking into consideration any potential costs that we’re able to negotiate out.

And clearly if there are locations that are not profitable and we’re not able to negotiate costs out, and that we don’t think that they’re significant incremental opportunity long term, we clearly would close the store. And it’s really part of an ongoing assessment that we perform each and every quarter.

Jeff Black - Barclays Capital

And then did you get the operating cash number for 3Q?

Michael J. Nicholson

For the current quarter? Is that the question?

Jeff Black - Barclays Capital

Yes.

Michael J. Nicholson

In terms of operating cash flow for the quarter, taking into consideration the impact of working capital, it was approximately breakeven.

Operator

Your next question comes from Brian Tunick - J.P. Morgan.

Brian Tunick - J.P. Morgan

I guess for Kay, we’re just curious as far as Gary and Christine go, would you just talk about how you’ll work with them differently versus the prior leaders before at the divisions and really how open you’ll be to having them influence, you know, your thinking on the company. Thanks.

Katherine Lawther Krill

Well, thanks, Brian. I think that, you know, the divisionalization is something that I’ve really wanted to do for a very long time. And I feel now we have the strong leadership with Gary and Christine and Brian to be able to do this. What we have transferred over to them is the fall marketing and visual and planning and allocation. Those are the new functions that transferred to the division presidents. Merchandising and design and stores have always been with the presidents.

But I feel like now it’s definitely a more holistic control of the business and they’ll be able to affect it more expediently and definitely make decisions quicker. I, for one, am losing direct reports which is a very good thing that I’ll be down to seven now. So I’m going to spend a lot of time with those division leaders and really working with them, because they are new, to really understand where we’re going so we’re all totally aligned. And I have to tell you, it’s a new day for me.

I’m very excited about their leadership and what they bring to Ann Taylor as far as their experience. We’re all in a very strong learning pattern right now and I think that we’re all operating as a very solid tight team.

Operator

Your last question comes from Lorraine Maikis - Merrill Lynch.

Lorraine Maikis - Merrill Lynch

Can you just update us on some of your ancillary initiatives like maternity at Loft and collection and beauty at Ann? And then if you have any strategic shifts given the environment for those businesses.

Katherine Lawther Krill

Definitely we are on hold with beauty right now. We’re really not focusing on that as you can imagine. It was less than 1% of the business at Ann Taylor, so that’s really on hold. We’re focusing on the greater categories. Celebrations we still have in the stores and we’ll focus on that online and we’re actually trying to come up with a growth plan for that, because we still think that’s very viable. And we are phasing out of maternity in Loft as of spring ’09.

Lorraine Maikis - Merrill Lynch

And then the Ann Taylor collection business?

Katherine Lawther Krill

That really fell into as far as this quarter, going into fourth quarter that really fell into our good, better, best strategy within Ann Taylor. We still have the better aspect of the assortment that’s really allocated to the stores that really need it; the high profile, more flagship stores; upscale locations. So it’s still part of the assortment, it’s just not designated as a separate business any longer.

Operator

This ends the Question-and-Answer session of today’s call. We will now turn things back over to Miss Krill for any closing remarks.

Katherine Lawther Krill

Thank you all for joining us this morning and have a great day.

Operator

Thank you for participating in today’s conference. You may now disconnect.

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Source: Ann Taylor Stores Corporation Q3 2008 (Qtr End 11/1/2008) Earnings Call Transcript
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