AnnTaylor Stores Corporation Q4 2008 Earnings Call Transcript

AnnTaylor Stores Corporation (ANN)

Q4 2008 Earnings Call Transcript

March 6, 2009 8:30 am ET

Executives

Maria Sceppaguercio – SVP, Communications and IR

Kay Krill – President and CEO

Mike Nicholson – EVP, CFO and Treasurer

Analysts

Betty Chen – Wedbush

Sam Panella – Raymond James

Jennifer Black – Jennifer Black & Associates

Lorraine Hutchinson – Banc of America

Kimberly Greenberger – Citigroup

Dana Telsey – Telsey Group

Stacy Pak – SP Research

Michelle Tan – Goldman Sachs

Jeff Black – Barclays Capital

Brian Tunick – JP Morgan

Tracy Kogan – Credit Suisse

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the Ann Taylor Corporation fourth quarter and fiscal year 2008 earnings conference call. At the request of the company, today's conference call is being recorded. If you have any objections, you may disconnect at this time. Following prepared remarks by the company, you will have the opportunity to ask questions.

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's President and CEO, Kay Krill, and our CFO, Mike Nicholson.

Earlier this morning, we issued results for fourth quarter and full year of fiscal 2008. As indicated in our release, our GAAP results were significantly impacted by non-cash charges associated with goodwill and asset impairment, as well as charges associated with our strategic restructuring program. Taken together, these charges totaled $346 million on a pretax basis in the quarter. Only about $4 million of these charges were cash charges, with the lion's share being non-cash charges. For the year, goodwill and asset impairment and restructuring charges combined totaled $376 million on a pre-tax basis, again with the vast majority of these charges being non-cash charges.

Excluding the impact of the restructuring and impairment charges, operating loss in the quarter totaled $93 million, and for the year operating income totaled $4 million. On the same basis, net loss per diluted share totaled $1.03 for the fourth quarter, and for the year we reported earnings per diluted share of $0.05. 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 provisions 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.

Kay Krill

Good morning, everyone, and thank you for joining us.

Let me begin my remarks this morning by stating that in my over 30 years in this industry, I have never experienced an environment as difficult as the one we've had this past fourth quarter. Consumer confidence reached historically low levels, and spending on discretionary items such as women's apparel has slowed significantly. While this economic crisis was felt across all demographics, the aspirational luxury consumer was particularly hard hit, including the professional working woman, our Ann Taylor division core client.

During the quarter, the overall retail industry confronted weak traffic, coupled with significant consumer resistance to spend, which led to unprecedented promotional activity to clear through inventory levels that were built in anticipation of stronger sales. When the traffic did not develop, we aggressively marked down merchandise to clear out inventory. As a result, fourth quarter margins deteriorated significantly.

In the current quarter, we expect our sales to remain under significant pressure, but from a bottom line point of view, we see the fourth quarter as the trough, and we expect to report a significant improvement this quarter in gross margin, and to a lesser extent, SG&A. Thus, while there is little we can do to change the macro environment, we are managing the business very aggressively, with a relentless focus on delivering compelling product at all divisions, as well as cost reductions, inventory management, and cash preservation, while simultaneously making prudent investments in our brands.

In terms of our cost reduction focus, we generated approximately 40 million in ongoing annualized savings in 2008 from our strategic restructuring program, and we expect to drive incremental savings of 35 to 40 million in 2009. Much of these savings benefit SG&A, which has been trending favorably for the past few quarters and which we expect to continue to do so in 2009.

A heightened area of focus for SG&A cost reduction this year involves our store optimization program, where we are aggressively exploring opportunities to improve our overall tenancy costs. Furthermore, we also expect to see incremental benefits in gross margin this year as our new Chief Supply Chain Officer focuses her team on reducing our sourcing costs in order to improve IMU, increasing our speed and flexibility and continuing to consolidate our vendor base.

Mike will take you through the details of our restructuring program a little later, but let me emphasize that we will continue to explore any and all opportunities to drive down our costs of doing business. Another significant area of focus for us is inventory management, where we have been successful. In fact, we closed the fourth quarter with total inventory down 32%, and we will continue to take a very conservative and disciplined approach in 2009. For spring, we have positioned our receipt plan down 25%. And for fall, we are planning to again be very conservative, while maintaining maximum flexibility to chase into market demand. We anticipate that our healthy inventory position will be a primary driver for improved gross margin as we move through 2009.

Turning to cash, as you know, cash management and preservation will continue to be critical this year. We ended fiscal 2008 with 112 million in cash, and importantly we generated approximately 60 million in operating cash flow, and more than 30 million in net cash flow in the fourth quarter, despite the very soft quarter we experienced. Cash will continue to be a key area of focus for 2009. And in addition to the cost reduction and inventory management efforts we have underway, we have dramatically reduced our capital spending for 2009 to further support this focus.

For perspective, capital spending totaled 146 million in 2007, and about 100 million in 2008, and we are forecasting to spend only 35 million in 2009. In another action to ensure our cash position remains strong, we just recently drew down 125 million, or half of our 250 million revolver, as insurance against potential disruption in the credit markets should we need access to cash during our typical working capital build in spring. Just to be clear, our plans do anticipate that we end 2009 with a cash position that is approximately even with our cash position at the end of 2008, excluding any borrowings under the revolver.

And finally, turning to our focus on our brands, which I view as the single most important element of our long-term success, let me start by commenting on the important work we have done to further differentiate Ann Taylor and Loft, which is critical to the future success of both brands. Ann Taylor has always been more sophisticated than Loft, and the repositioning of the brand emphasizes this sophistication with a modern and chic point of view. Loft, on the other hand, has always been a more casual brand, and our positioning for 2009 and beyond is decidedly casual, relaxed, and fun. We expect this differentiation to be far more apparent to you as we enter the fall season.

Starting with Ann Taylor, the fourth quarter was extremely challenging for the Ann Taylor division, with comparable store sales down 29%. While we have acknowledged that our product assortments could and should have been more modern and versatile, we believe that much of the softness we are experiencing relates directly to the impact the recession is having on professional working women. The aspirational luxury sector of women's apparel has been especially hard hit by this downturn, as has the key category of professional business attire, which represents about half of Ann Taylor's assortment.

As I said, we were very aggressive promotionally during the quarter to move through inventory. This promotional stance eroded our AUR, and despite higher conversion and increased unit sales, our overall transaction size on a dollar basis suffered. As a result, the Ann Taylor division experienced significant margin erosion in the quarter. On the positive side, we did move through inventory, and ended the quarter with in-store inventory down 27% and total inventory down 39%.

I feel good about our inventory levels heading into spring, and as I mentioned earlier, inventory receipts for the season are down significantly from prior year. We expect this clean position to enable us to begin to achieve a more rational and strategic promotional and markdown approach, which we believe will support improved gross margins versus Q4 beginning in the first quarter.

Looking beyond spring, when the product vision and brand positioning work of the new team will be in stores, I remain very optimistic that Ann Taylor will be a relevant destination for her wear-to-work needs. The brand will be positioned to capitalize on more modern and versatile wear-to-work dressing trends, and we'll also market the brand's high quality and excellent value. We believe strongly in the enduring power of this brand and in the leadership team we now have in place to rejuvenate it.

Now let me turn to Loft. Sales at Loft were under significant pressure during the fourth quarter due to the extremely soft economic and consumer environment. The resulting highly competitive promotional environment and our focus on moving through inventory during the quarter led to a negative 22 comp at the division and a very soft gross margin. On the positive side, we did end the year very clean from an inventory standpoint, with total inventory at the division down 37% and in-store inventory down 41%.

As with the Ann Taylor division, Loft's spring inventory receipt plan is extremely conservative, and we do expect this will support stronger gross margin in the first quarter. With its offering of fashion and quality at unexpected prices, Loft is positioned well for today's soft economic environment. In addition, Loft offers the versatile and casual product that she is seeking today. In 2009, we plan to better leverage these unique qualities of casual fashion quality and value in our marketing and client communications. Importantly, we know that our Loft clients are very loyal and highly engaged. We believe these important brand attributes will resonate in the current economic climate and benefit the brand in 2009.

A key objective for Loft in 2009 centers around re-architecting the way we conceive and flow seasonal product throughout our stores, which we expect will result in a more consistent and exciting product story. Not only will this further engage our very loyal client, but it also enable a more profitable and rational promotional cadence. We have also begun to better define and improve our marketing for the brand. We believe the new imagery for the spring season clearly expresses the essence of Loft. Finally, and most importantly, we are confident that our new Loft leadership will be successful, not only in 2009, but also in maximizing the Loft brand's potential for the longer term.

Turning now to factory, the factory channel was significantly impacted by the discounting that occurred in malls and other channels in the fourth quarter. Despite these pressures, factory continued to deliver relatively solid gross margin during the fourth quarter. Also in the factory channel, we ended the year with 14 Loft outlet stores, in line with our original plans. Throughout 2009, we will monitor these newly-launched stores and we'll continue to fine-tune the concept as appropriate.

Finally, on our Internet business, we continue to view this as an important channel that compliments our store fleet and provides an efficient and easy way for her to shop with us. The Internet also provides us with a cost effective vehicle for communicating with our clients. We expect that this business will continue to show profitable long-term expansion.

With that, I would like to turn it over to Mike, who will take you through the financial details of the quarter and the year, as well as our viewpoint on 2009.

Mike Nicholson

Well, thanks, Kay, and good morning, everyone.

Today I would like to start my remarks with where I would usually end them, and that is with our balance sheet and cash position. As you well know, cash is king in this environment, and those companies that have strong balance sheets and ample liquidity are far better positioned to weather the current economic storm than those that don't. And I'm pleased that we are one of those stronger companies.

We ended the year with cash of $112 million and no debt, and we did this despite a very tough quarter by reducing our inventory exposure and aggressively managing expenses to conserve cash. We generated operating cash flow of nearly $60 million in the fourth quarter, and net cash flow of more than $30 million.

While we just tapped into our revolver as a precautionary measure given the ongoing uncertainty in the financial markets and in the event we need incremental cash to fund our typical working capital build for spring, we expect to generate solid cash in 2009. In fact, excluding any revolver borrowings, we expect to close fiscal 2009 with a cash level that is approximately even with our 2008 cash level, which as you know, was more than $100 million.

In terms of other actions we have taken to preserve cash, we have dramatically reduced our capital investment plans for 2009 to only about $35 million, which is 65% below our prior year levels. We've also planned spring receipts very conservatively on top of the 32% decline in inventory on a dollars per square foot basis that we achieved at year end 2008, and we are positioning our fall receipts conservatively as well.

Finally, during the quarter, we wrote down the carrying value of the goodwill on our balance sheet at a one-time non-cash cost of $287 million, and we impaired asset values on stores not included in our restructuring program as well as those that are, and I will discuss the impacts of these items that they had on our financial results in a moment.

Now let's turn to our results for the fourth quarter and full year. For the fourth quarter, net sales declined 19.5% versus year ago to $483 million on an overall comp store decline of 24.5%. By division, net sales at Ann Taylor declined 32% to $146 million on a comp store decline of 29.4%. At Loft, net sales declined 21% to $231 million, essentially in line with our comp store decline of 21.9%.

Gross margin for the quarter declined 13 margin points to 35.7% versus 48.7% last year, and this performance primarily reflected the impact of the very soft sales and the unprecedented level of promotional activity in markdowns across the sector, which caused us to be extremely promotional to clear through inventory. We believe that our gross margin performance in the fourth quarter marks our low point, and we expect that beginning in the first quarter we will begin to achieve significantly improved gross margin rates from this very depressed level.

Our 32% decline in total inventory at the end of the fourth quarter reflected a 26% decline in total in-store inventory and a 38% decline in our in-transit inventory. SG&A for the quarter was down 3%, or approximately $9 million to $265 million. This improvement largely reflected savings from our restructuring program and aggressive management of expenses, partially offset by operating a larger store base during the year and costs associated with the launch of Loft Outlet.

During the quarter, as previously mentioned, we recorded a $287 million pre-tax non-cash impairment charge on our goodwill. This charge resulted from our annual impairment testing and reflected the impact of the overall economic decline on our business performance and outlook, as well as our market cap and overall sector valuation. On an after-tax basis, this charge totaled $279 million, or $4.95 per diluted share in the quarter.

We also incurred pre-tax non-cash impairment charges totaling $27 million related to the impairment of store assets not included in our store restructuring program. The after-tax impact of these charges totaled $17 million, or $0.31 per diluted share.

Finally, as part of our strategic restructuring program, we incurred pre-tax restructuring charges totaling $33 million in the quarter. Approximately $29 million of these charges were non-cash and the remaining $4 million were cash charges. On an after-tax basis, restructuring charges incurred during the quarter totaled $21 million, or $0.37 per diluted share. So taken together, the impairments and restructuring charges during the fourth quarter totaled $346 million on a pre-tax basis and $317 million on an after-tax basis, or $5.63 per diluted share.

Excluding these impairments and restructuring charges, we reported an operating loss in the quarter of $92.8 million compared with operating income of $18.2 million last year. On the same basis, we reported a net loss of $58.1 million, or $1.03 per diluted share during the quarter, compared with net income of 11.5 million or $0.19 per diluted share in the fourth quarter of 2007.

In terms of our share count, weighted average diluted shares outstanding for the quarter declined 6.2% to 56.4 million shares versus 60.1 million shares in the fourth quarter of 2007. Our effective tax rate for the quarter was 14.5% versus 38.3% in the fourth quarter of 2007, and this decline primarily reflected the impact of the goodwill impairment charge taken during the fourth quarter, the vast majority of which was not tax deductible.

Depreciation and amortization in the fourth quarter totaled about $29 million, equivalent to the $29 million we recorded in the fourth quarter of 2007. And during the fourth quarter, we opened three new stores. One was an Ann Taylor factory store, and the other two were Loft Outlet stores. We also closed a total of 34 stores during the quarter, 24 of these were Ann Taylor stores, and 10 were Loft stores.

Turning now to a quick recap of our full year results, net sales for fiscal 2008 declined 8.4% versus year ago to $2.2 billion on an overall comp store decline of 14.8%. By division, net sales at Ann Taylor declined 21% to $689 million on a comp store decline of 19.9%. At Loft, net sales declined 7% to $1.088 billion on a comp store decline of 11.4%. Gross margin for the year declined 4.1 margin points to 48.1% versus 52.2% last year, reflecting margin erosion in the second half of the year as the economic environment deteriorated.

SG&A for the year was down 1% or approximately $11 million to $1.051 billion. This improvement reflected the benefit of our restructuring program and aggressive management of expenses throughout the year, partially offset by operating a larger store base during the year and costs associated with the launch of Loft Outlet.

In terms of the impact our restructuring and impairment charges had on our full year results, goodwill impairment was $287 million for the year, which was $279 million after-tax, or $4.87 per diluted share. Asset impairment totaled $30 million for the year, which was $19 million after-tax or $0.33 per diluted share. And finally, restructuring totaled $60 million for the year, which was $39 million after tax, or $0.67 per diluted share. Taken together, the cost of these charges was $376 million on a pretax basis and $337 million, or $5.87 per diluted share, on an after-tax basis.

As I mentioned previously, the vast majority, 95%, or approximately $356 million of these pretax charges were non-cash and had no impact on our cash position for the quarter or for the year. Excluding these impairments and restructuring charges, operating income for the year was $4.2 million compared with operating income of $189.4 million last year. On the same basis, we reported net income of $2.9 million or $0.05 per diluted share in 2008, compared with net income of $117.8 million or $1.86 per diluted share in 2007.

In terms of our share count, weighted average diluted shares outstanding for the year declined 9.6% to 57.4 million shares versus the 63.5 million shares in fiscal 2007, reflecting share repurchases during the first half of fiscal 2008. Our effective tax rate for the year was 10.1% versus 39.6% for 2007, and as I indicated previously, this decline primarily reflects the non-deductibility of the goodwill impairment recorded in the fourth quarter. Depreciation and amortization in 2008 totaled approximately $122 million versus $117 million in 2007. Capital expenditures for the year totaled $100 million versus $146 million in 2007.

In terms of new store activity, we opened a total of 66 new stores in 2008, comprised of four Ann Taylor stores, 25 Loft stores, 23 Ann Taylor Factory stores, and 14 Loft Outlet stores. We closed a total of 60 stores during the year, comprised of 33 Ann Taylor stores and 27 Loft stores, as part of our restructuring program. And we ended the year with 935 stores, comprised of 320 Ann Taylor stores, 510 Loft stores, 91 Ann Taylor Factory stores, and 14 Loft Outlet stores. And finally our total store square footage at the end of the year totaled approximately 5.5 million square feet, a 1.5% increase versus 5.4 million square feet at the end of 2007.

Turning now to our restructuring program, as you may know, the multi-year program was initially launched in January of 2008 and was subsequently expanded to include a more aggressive cost reduction focus as the year progressed. The program is now expected to generate total ongoing annualized savings of $80 million to $90 million by 2010, and we achieved approximately $40 million of these savings in fiscal 2008, exceeding our previous expectation of $35 million in savings.

One-time costs of the program are now expected to be approximately 95 to $100 million, of which $92 million have already been incurred during the 2007 to 2008 period. And importantly, of the total program costs, approximately $65 million are expected to be non-cash costs associated with the store closure program, and virtually all of the savings are expected to be cash savings. In fiscal 2009, we expect restructuring costs to be less than $5 million, and we expect incremental ongoing savings to be in the $35 million to $40 million range.

As we stated in our press release this morning, we have added 46 stores to our store closure plan, and now expect to close 163 stores under the program. Of the 163 stores planned for closure, 70 are Ann Taylor Stores and 93 are Loft stores. The 46 stores recently added were previously borderline performers relative to our performance standards, and have deteriorated in the current environment.

In fiscal 2009, the company plans to close 37 stores under the restructuring program comprised of 10 Ann Taylor stores and 27 Loft stores, with the balance of the stores identified for closure currently targeted to close in fiscal 2010. We will also continue to aggressively evaluate our store fleet and take action where we believe performance is not likely to meet performance standards. And finally, during fiscal 2009, we expect to open 14 stores.

Before turning to our outlook for the year, I would like to take a moment to share my thoughts relative to our real estate strategy for 2009. In addition to the expansion of our store closure program and our minimal store opening plans for 2009, we will also be stepping up our efforts to reduce costs associated with our remaining store fleet. As you know, the commercial real estate markets have been dramatically impacted by the downturn in the economy and many markets are seeing vacancy rates on the rise. We believe this turmoil provides a unique opportunity for landlords and tenants to come together to find solutions to keep stores open in markets with a viable long-term outlook.

Turning now to our outlook, as you know, the current volatility and uncertainty makes predicting financial results with any precision very difficult. Nevertheless, I wanted to provide you with a way to think about our performance that would be consistent with how we are thinking about it. For the first quarter, we expect the current weakness in consumer confidence and spending to persist, and as a result, sales are expected to again be under significant pressure. However, we expect our exceptionally clean inventory position and our conservative receipt plan to support a significant sequential improvement in gross margin in the first quarter versus the trough level we experienced in the fourth quarter of 2008.

For perspective, over the past four years, our gross margin rate in the first quarter has averaged about 54%. Now while I'm not in a position today to provide you with a specific gross margin rate forecast, I do expect that our first quarter gross margin rate will improve meaningfully from the fourth quarter, and in the month of February, we did see this improvement materialize.

SG&A in the first quarter is expected to trend favorably on both a sequential and year over year basis, and we would expect expenses to be approximately $250 million for the quarter. Regarding our expectations for the full year, we expect that given the macro environment and the particular impact it has had on professional working women, we expect our sales to continue to be under significant pressure for the year, with some improvement expected in the second half due to anticipated product improvements, a more rational promotional environment and an improvement versus our very depressed second half 2008 performance.

Total square footage is expected to decline approximately 2% at year end, reflecting the impact of the 37 stores being closed in fiscal 2009 under our restructuring program, partially offset by the opening of 14 new stores. Our gross margin rate is expected to improve for the year due to our aggressive inventory management plan and the expectation of a gradual return to a more rational promotional activity in this sector over the course of 2009.

Selling, general, and administrative expenses are expected to be below year ago, reflecting restructuring savings and our ongoing focus on cost reduction. Incremental restructuring savings for the year are expected to total $35 million to $40 million, and one-time restructuring costs are estimated to be less than $5 million. We will continue to relentlessly focus on maintaining a healthy balance sheet and preserving cash, and expect capital spending to be approximately $35 million for the year. And finally, we expect to end the year with a cash position, excluding any borrowings from the company's revolving credit facility, that is approximately even with our cash position at year end 2008.

And with that, I will turn it back to Kay.

Kay Krill

Thanks, Mike.

Before we go to your questions, I would like to leave you with these thoughts. This past quarter was without question the most difficult I have witnessed in my career. And while I don't anticipate the macro or consumer environments to improve in the near term, I absolutely expect our gross margin performance to do so.

Our exceptionally clean inventories position to us achieve a healthier promotional and markdown cadence than we experienced in fourth quarter. While I so expect the broader sector to also be focused on improving gross margins in 2009, we are not counting on business as usual to achieve the much better gross margin performance we are expecting in the first quarter. At the same time, we are extremely focused on our SG&A structure, and we're exploring new opportunities to reduce costs, including those we shared with you today, in the areas of sourcing and real estate, among others, to further drive down our cost of doing business.

We're also very focused on preserving cash to ensure we remain highly liquid, and we fully expect to end fiscal 2009 in a strong cash position. Finally, we will continue to focus on improving our product assortment and in-store environments to ensure that they are as relevant, focused, and compelling as possible.

With that, let's open it up to your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Betty Chen with Wedbush.

Betty Chen – Wedbush

Thank you. Good morning, everyone. And congratulations on managing your balance sheet so well in this environment.

Kay Krill

Thank you.

Betty Chen – Wedbush

I was wondering if you can talk a little bit about some of the trends you are seeing right now, Kay. It's obviously very difficult, and we're hearing that customers are increasingly looking for newness. I know you've talked about planning spring very conservatively and hoping for some improvements, especially in the back half as the commercial environment eases. How should we think about the first half and some of the levers you have to try to draw consumer interest and continue to improve conversion as you see so far in February?

Kay Krill

Okay. Overall, our sales are still under pressure, and we're experiencing comp weak business across the business. However, Loft is trending better than Ann thus far in the season. Our stores are really the cleanest that they have ever been, and we'll continue to control our inventories this year, which I think is really critical for 2009. This should significantly improve our gross margin results, and as Mike said, we realized improvement in February already. This year is really all about maximizing gross margin dollars. I think it's less about comp than gross margin dollars.

And let me just give you a little glimpse by brand for what I feel about spring. Ann, I think our spring product is – definitely could have been more improved than it is. It gets better as we head into the second quarter. It is focused on dresses and more versatile sportswear pieces. I do think our tops assortment could have been stronger, and it definitely will be for fall. Our May product really begins to reflect a more modern hand, and definitely reflects more brand appropriate marketing. However, the product and marketing for fall, in my opinion, is our best yet. The team has done an amazing job. We're going to maximize the gross margin in this division as best we can for the first half, and that's really our focus.

For Loft, our product assortment definitely reflects a more casual, fashionable, and fun element, and we're seeing strength already, especially in casual bottoms and tops. We have incredible value at Loft, and we need to pound on that message harder for spring and going into fall, because that's our strong suit, and we need to get that message out in a compelling way. So I think we have several levers. I think maximizing our inventory that we do have, maximizing gross margin dollars, and really differentiating and maximizing the essence of each brand and marketing to her in a compelling way that really highlights our value message.

Betty Chen – Wedbush

On that case, should we see marketing dollars increase year-over-year?

Kay Krill

No, no, no. This is not about that. It is really about marketing to our core client and marketing that value message in a more compelling way. Absolutely, we're not increasing our marketing dollars. As a matter of fact, they're going south.

Betty Chen – Wedbush

Great. Thank you very much, and best of luck.

Kay Krill

Thank you.

Operator

Your next question comes from the line of Sam Panella with Raymond James.

Sam Panella – Raymond James

Okay. Good morning. Just curious about the strategy bringing outside brands into – noticing them in Ann Taylor stores as well as Loft. I understand it's probably a small percentage of the mix, but just what are your thoughts there, and is that something you are going to pursue going forward?

Kay Krill

No, Sam, we're really not. It's less than 1% of the Ann Taylor brand, and it's primarily in dresses, and those dresses have been very successful. We'll continue to have them as part of our assortment, but we're not really exploring any to make this a bigger part of the business. We have hired, as I have told you all I think on the last call, an outstanding lead designer in the Ann Taylor business that I'm thrilled about, and her first assortment is going to be for fall, and we really are happy with the breadth and depth of what she can accomplish without having to go outside. Regarding Loft, Gary is really pulling back on outside brands, and we are really focused on doing this and designing all of our product internally.

Sam Panella – Raymond James

Okay.

Kay Krill

So you will see less of that in Loft.

Sam Panella – Raymond James

Okay. Thanks and good luck.

Kay Krill

Okay, thank you.

Operator

Your next question comes from the line of Jennifer Black with Jennifer Black & Associates.

Jennifer Black – Jennifer Black & Associates

Good morning.

Kay Krill

Good morning.

Jennifer Black – Jennifer Black & Associates

I wondered if you could elaborate a little bit at the Ann Taylor division, as far as your newest floor set, between denim, wovens, knits, as well as jackets, and I guess accessories as well, and I'm curious about – you had a see-through kind of wrapped dress in your windows this last week. What kind of reaction are you getting to novelty? Thank you.

Kay Krill

Jennifer, we are – we just set that new store set at the end of last week, so I'm not really sure the performance by style at this point. But I think that with the Ann Taylor business, we are seeing some spots of good performance, especially interestingly, suits are perking up a little bit. And I think that that is really because of interview needs possibly right now, but the suit business is enjoying some success, as well as the denim, because as you know, we're price pointing it, because we had really invested a little bit too much in that category.

And we're seeing some – most of pieces in the elements of the assortment that we are seeing success are highly novel, highly fashionable, and things that are not in her closet. It's really what you would expect to find right now. And in Loft, as I said, it's really the casual elements, the casual bottoms, the casual tops, casual dresses, anything that represents that casual lifestyle is really what we're seeing success with right now.

Jennifer Black – Jennifer Black & Associates

Okay, great. And I just wondered, it appears as though you are testing some promotions. I haven't seen the promotion that I saw. Is that correct?

Kay Krill

Absolutely. We are testing constantly right now. We're taking control groups and within – across the country in subsets of stores to really test a lot of different overarching promotional strategies to see what will drive the business.

Jennifer Black – Jennifer Black & Associates

Okay. Thank you. Good luck.

Kay Krill

Okay, thanks, Jennifer.

Operator

Your next question comes from the line of Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson – Banc of America

Thank you, good morning.

Kay Krill

Good morning.

Lorraine Hutchinson – Banc of America

Can you discuss the reasons for drawing down the revolver and sort of what led you to that decision versus just using it in the case that you needed it? And also if you could just review the covenants associated with that debt for us.

Mike Nicholson

Yes, happy to, Lorraine. As I mentioned in the opening comments, it was really more a precautionary measure. As you know, looking back historically in terms of the cash flow trends of our business, we traditionally use cash during the first quarter, build it back into the second quarter, used cash in the third quarter and built it back in the fourth quarter. And our expectations for this year really are no different, and acted prudently to ensure that we maintain a very comfortable level of cash through this economic storm. You know, candidly, we are in unchartered territory. And quite frankly, as CFO I don't want to take any risk to the business in the event that the turmoil becomes even more challenging and more difficult. In the event we need the cash, I want to have access to it.

In terms of the covenants, the way I would think about the covenants, it truly is a covenant-light deal. Essentially, there really is only one covenant, a ratio of earnings to fixed charges that relates to the only trips in the event that our liquidity falls below $37.5 million. And liquidity under the terms of our agreement is defined as our cash on hand, plus availability under the line. So I really – from my perspective, from where I sit, I really don't see us ever approaching that point.

Lorraine Hutchinson – Banc of America

Okay. Then if I'm interpreting your comments correctly, should we be expecting gross margins to decline sequentially, at least through the first half and then perhaps – or sorry, decline year over year for the first half and then start getting better in the back half?

Mike Nicholson

The way I'd think about it is in terms of the first quarter, I would expect to see significant improvement in the first quarter of '09, off of the fourth quarter of '08. But I think we also need to recognize that in the first half of 2008, we had very solid results, healthy gross margin. So I think your observation with respect to first and second quarter pressure versus the prior year, I think that's a reasonable way to think about it.

Lorraine Hutchinson – Banc of America

Thank you very much.

Operator

Your next question comes from the line of Kimberly Greenberger with Citigroup.

Kimberly Greenberger – Citigroup

Good morning.

Kay Krill

Good morning.

Kimberly Greenberger – Citigroup

Mike, my questions for you, the guidance to end 2009 with cash is very similar to what you have got on the balance sheet right here, despite the benefit of, I think, a $65 million cut to CapEx. Does that imply – can we do the math simply that you are expecting about a $65 million loss in '09, or what are the other factors we should consider?

Mike Nicholson

So the way I'm looking at – thinking about it, Kimberly, assuming no improvement in working capital, as well as a flat cash position, $35 million of capital spending, and about $110 million of a non-cash depreciation add-back, that math suggests about a $75 million pretax operating loss for the year.

Kimberly Greenberger – Citigroup

Okay. Great, thank you. That's helpful.

Operator

Your next question comes from the line of Dana Telsey with Telsey Group.

Dana Telsey – Telsey Group

Good morning, everyone. As you think about the current environment and the different levers you have both on margins and expenses, how do you look at scenario analysis in terms of here's where we are today? And are you in the second stage, third stage, both in terms of the margin opportunity given the new pricing environment, and on the expense side? Thank you.

Mike Nicholson

First I will take the expense component of the question. I think that we've demonstrated over the course of the year in a series of actions with respect to our restructuring program that we are taking this challenge with respect to cost reduction very seriously. Going back 12 months, we thought we had a $50 million opportunity, and we're now looking at an opportunity in the range of $80 million to $90 million. And as both Kay and I mentioned during our opening comments, we are going to continue to aggressively look at opportunities in the area of SG&A. And then in terms of gross margin, I really think with Paula being relatively new in her role, I would kind of term it, really, we're in the early innings of the game, and we will begin to see improvement from a cost reduction perspective as it relates to cost of product, as we move into the back half of 2009 and then into 2010.

Operator

Your next question comes from the line of Stacy Pak with SP Research.

Stacy Pak – SP Research

Great, thanks.

Kay Krill

Hi, Stacy, welcome back.

Stacy Pak – SP Research

Thank you. Thanks very much. Good to be back. Question, Kay, on just sort of the customer, given what they have been seeing in terms of the markdowns and the promos, et cetera, what is the plan to sort of hold on to that customer and teach them to buy at regular price after they have been trained sort of on these promos and markdowns? And can you guys share the comp metrics for the quarter that just ended, and maybe talk about where you saw a difference in February. And then also Kay, can you just expand on the direction the product should go in? Is Loft where you want it, but Ann needs to improve? And just sort of expand a little bit there. Thanks.

Kay Krill

Okay. You know, Stacy, that's the million dollar question, is whether the consumer is going to have a full price appetite, a strong full-price appetite, during 2009. We are seeing, though – we're seeing her nibbling on pieces that are not in her closet, pieces that are fashionable and novel and more emotional kinds of purchases, as well as needs. Like, you know, I didn't think anybody really needed a new suit, but we are seeing the suit business in Ann Taylor take an uptick, which I think is very encouraging, but I also think it's definitely a sign of the time that people need interview suits, and Ann Taylor is definitely top of mind for that.

As far as promos go, as I responded to Jennifer, we are definitely testing promotional strategies and testing overarching kind of promotions to entice her to purchase. We did not buy our inventory with any kind of depth that we normally have. We are really lean for the first half of the year, so we're not expecting to this have markdown cadence that we've always had, and actually our focus is on maximizing gross margin dollars rather than on comps. So I think that we saw success with that in February, and we're going to continue to push that lever for the remaining of first half.

As far as product goes, as I said, Ann Taylor product for the first quarter I think is more challenge than it is for the second quarter. Second quarter was designed and marketed and bought with a different hand, and I think that we are going to begin to see, as of May actually, Ann Taylor look more modern and sophisticated and where we're headed for fall.

Having said that, I think the third quarter product is amazing, and actually much better than we've ever – than I've ever seen. Actually, I think it's the strongest assortment we've seen, and I look forward to previewing that with you all in April. We are going to try to put together a preview for fall for both brands at the end of April, so you will be getting a message from Judy on that shortly.

As far as Loft goes, I think that Loft product is definitely brand appropriate right now, and actually on the mark. It is just a matter of us adding what Gary is bringing to the table, which I think is really powerful and very strong, for the back half of the year, and is really re-architecting the assortment to have a core base assortment with key items layered on top of that, and then fashion newness on monthly basis. So the assortment really hangs together well, and is less fragmented and is really positioned and bought for profitability. So I will look forward to seeing greater success with Loft as we progress through the year.

Stacy Pak – SP Research

That's great, Kay. And then just a follow-up on that then, why are the Loft inventories so much lower than stores? And Mike, if you could just address the comp metrics, that would be great. Thank you.

Mike Nicholson

Sure. Fourth quarter at the total company level, the comp metrics, it was really a story of DPT. And so as I think about our comp performance, the majority of that performance related to erosion in AUR, with some portion of it relating to UPT but the majority of the comp impact was driven by an erosion in AUR.

In terms of inventory at the end of the year, as I mentioned total company was down 32% and dollars per square foot basis and down 39%. And interesting in of composition, carry-over – Ann carry-over was down almost 45%, and I'm defining carry-over as January store set and prior. Loft's total inventory down 37% dollars per square foot basis versus last year, and their carry-over position was actually down 70% year on year, as Gary and the team were very focused in the back half of the fourth quarter in liquidating carry-over goods.

Stacy Pak – SP Research

Right, but I guess my question – and I appreciate that – my question, though, was why is Loft down so much if you feel their product is right? I mean, obviously they're comping not great, it’s a lot lower than it has comped.

Kay Krill

They're cleaner, Stacy, in markdown inventory. They were heavier in the fourth quarter and they are cleaner mostly in non-full priced goods. They are over 80% full price as they headed into February, which we've never been that clean.

Stacy Pak – SP Research

Okay. And then can you address –

Kay Krill

I think we need to move on, Stacy, because we've got a limited amount of time and I want to get more people in, okay?

Stacy Pak – SP Research

Thanks.

Kay Krill

You can talk to Maria and Judy and Mike later.

Stacy Pak – SP Research

Okay.

Kay Krill

Thanks.

Operator

Your next question comes from the line of Michelle Tan with Goldman Sachs.

Michelle Tan – Goldman Sachs

Great, thanks. I was wondering if you could give us some more detail on the SG&A pressure. As I look at the numbers, even with the new concept investment, it would seem like the cost savings that you got this quarter would get at least the 3% in SG&A decline that you recorded, and with sales down 20%, I would have thought there would be a little more relief on the variable cost component on top of that, so can you talk about what the offsets are and how we should think about that going forward?

Mike Nicholson

Yes, Michelle, what I would like to do is, we can follow-up after the call and we can walk you through the puts and takes for the quarter and dive a little bit deeper in terms of how we're thinking about the components of change in 2009.

Michelle Tan – Goldman Sachs

Okay, maybe you could just highlight what the – you know, couple of pressure points might be just qualitatively?

Mike Nicholson

Yes, I mean, what I'd say is I think about our – the composition of our SG&A and the component that is four wall related. I mean, essentially, our store operating model – we are essentially at these levels of sales volume, operating at minimum matrix, and most efficiently as we can. So at this level of sales, the variable component of SG&A becomes a bit challenging.

Michelle Tan – Goldman Sachs

Okay. Thanks, that's helpful. And I would love to follow-up afterwards.

Mike Nicholson

Sure. Hey, the other point I just want to make in terms of the conversation earlier with Kimberly regarding 2009, I want to just clarify that the discussion that we had regarding the operating results for the year was meant to be theoretical in nature and not intended to represent specific guidance of the company.

Operator

Your next question comes from the line of Jeff Black with Barclays Capital.

Jeff Black – Barclays Capital

Hey. So we'll take in that theory, that $0.85 loss. But anyway, Mike, what – it looks like trade notes really crept into the accounts payable picture. I mean, what does this mean over the last two quarters? As we look at the balance sheet, does this mean that your vendors are really tightening up on what they are willing to do with you? Thanks.

Mike Nicholson

No, Jeff, I don't think so at all. In fact, if I look back over the last four quarters, we have been successful in moving our supply base off of letters of credit to open accounts. So if anything, Jeff, the way I interpret that is a vote of confidence from the supply base that they are very comfortable working with Ann Taylor, they are comfortable with our liquidity, and they are confident that we will be a survivor in this environment.

Jeff Black – Barclays Capital

And then just an add-on to the last question, how much occupancy deleverage did we see in the quarter?

Mike Nicholson

I don't have that specific information in front of me, but again, we can follow-up after the call.

Jeff Black – Barclays Capital

Okay, good. Thanks.

Operator

Your next question comes from the line of Brian Tunick of JP Morgan.

Brian Tunick – JP Morgan

Thanks. Good morning. I guess for Mike, I think we're going to get a lot of questions on the revolver I think here today, so maybe if you could spend another couple of minutes or seconds just talking about from an inventory build perspective from here, or your internal cash flow projections, what do you expect sort of this to look like, I think, over the next couple quarters?

Mike Nicholson

Yes, I mean, I guess, Brian, from where I sit today, in terms of looking at our plans for the first half of the year and the seasonality in working capital, as well as looking back on our historical performance, in the first quarter, we will consume some cash as we build our working capital, but I expect to end the first quarter still in a cash position, a positive cash position outside of the proceeds from the revolver, and based upon our current cash flow projections for the second half – or the second quarter of this year, I fully expect by the end of the spring season for us to be back in a position, from a cash basis, excluding proceeds on the revolver, where we ended the year.

Again, as I mentioned, in terms of draw down, it was really meant to be a precautionary strategy and really relates to the ongoing uncertainty in the external financial markets and nothing to do with the health of our business or our expectation with respect to the cash that we expect to generate this year.

Brian Tunick – JP Morgan

And then in terms of inventories, I mean, what should we be thinking? Kay sounds very optimistic about the third quarter. I mean, how are we thinking about you guys buying inventories for that period?

Kay Krill

We are still going to buy very conservatively, Brian. We have definitely peeled back – we still have the mindset that we bought for spring going into fall, and we're waiting to see. We still have about eight weeks before we can really chase into – well, until we can – you know, it stops that we can chase into it. So we are going to gather our marketing looks and figure out our strategies for fall as far as how we are going to get this message out and then strengthen the buys according to that. But really, we still are going to have a conservative mindset as we purchase fall, which I think is the prudent thing to do at this point.

Brian Tunick – JP Morgan

All right, good luck.

Operator

Your next question comes from the line of Tracy Kogan with Credit Suisse.

Tracy Kogan – Credit Suisse

Thanks. Another quick question on inventory, can you talk about how you are planning inventory units this year as you try to balance being prudent with your inventory buys with having the stores look not completely empty? Thanks.

Mike Nicholson

Our spring receipt plan on average across the divisions are pitched down in the range of 20 to 25% versus the prior year. And from where I sit today assessing the current run rate of the business as well as our receipt plan, I would expect that we would end the first quarter with inventory down in the range of 20 to 25%.

Tracy Kogan – Credit Suisse

That's in units?

Mike Nicholson

That's in a dollar basis, and units is fairly representative.

Tracy Kogan – Credit Suisse

Okay, thank you.

Operator

This ends the question and answer session of today's call. We will now turn things back over to Ms. Krill for closing remarks.

Maria Sceppaguercio

Hey, it's Maria. Before we turn over to Kay, I just want to provide clarification based on something that Jeff had said earlier. We have not provided today any operating guidance for the full year, and we wanted to give you a way to think about our results for the quarter and for the year so that it was helpful to you as you thought about how to do your job.

However, what I will say is that there are a number of factors that could vary by a little bit, that could end up in a very different place than a $75 million operating loss or an $85 million operating loss as was talked about today. That was theoretical, and that is not necessarily what we're seeing. So we don't want you to go out and think that we're providing guidance, because we're really not. And there are a number of variables in this very volatile and uncertain environment that could change, and the numbers could be significantly different than that.

So with that, I will just hand it back to Kay for closing remarks.

Kay Krill

Okay, thank you very much for joining us this morning, and have a great day. Bye-bye.

Operator

This concludes today's conference call. You may now disconnect.

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