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Wet Seal (NASDAQ:WTSL)

Q4 2012 Earnings Call

March 21, 2013 4:30 pm ET

Executives

Jennifer Ehrhardt - Vice President and Corporate Controller

John D. Goodman - Chief Executive Officer and Director

Steven H. Benrubi - Chief Financial Officer, Executive Vice President, Principal Accounting Officer and Corporate Secretary

Analysts

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Eric M. Beder - Brean Capital LLC, Research Division

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Christopher Thomas Donnelly - Pacific Rock Capital, LLC

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

Maria C. Vizuete - Piper Jaffray Companies, Research Division

Operator

Greetings, and welcome to the Wet Seal, Inc. Fiscal Fourth Quarter 2012 Earnings Results Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jennifer Ehrhardt, VP, Corporate Controller for the Wet Seal, Inc. Thank you. You may begin.

Jennifer Ehrhardt

Good afternoon, everyone. Thank you for joining us today. I'm Jennifer Ehrhardt, Vice President and Corporate Controller for the Wet Seal Inc. Presenting on today's call will be John Goodman, our Chief Executive Officer; and Steve Benrubi, our Chief Financial Officer.

Before they proceed, please note that certain statements during this call may contain forward-looking information. Forward-looking statements are based on current expectations and projections about future events and are subject to risk, uncertainties and assumptions about our company, economic conditions in market sectors and the industry in which we do business, among other things. These statements are not guarantees of future performance, and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Actual events and results may differ from those expressed in any forward-looking statements due to a number of factors. Factors that could cause our actual performance, future results and actions to differ materially from any forward-looking statements include, but are not limited to, those discussed in Risk Factors within our Form 10-K for the fiscal year ended January 28, 2012 and our Form 10-Q for the fiscal quarter ended October 27, 2012, as filed with the Securities and Exchange Commission.

On today's call, we will make references to operating income and loss, net income and loss and income and loss per diluted share for the fourth quarter and full year of both fiscal 2012 and 2011 before certain charges. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons. An explanation of why these non-GAAP financial measures are useful and how they're used by management can be obtained from the company's website, wetsealinc.com.

With that, I will turn the call over to John to begin.

John D. Goodman

Thanks, Jennifer, and good afternoon, everyone. I'm thrilled to be on board at Wet Seal and have the opportunity to speak with you on our first earnings call since I joined the company in January. I'll begin with a review of my early findings, followed by a discussion of our strategic plans for fiscal 2013 and how we have literally hit the ground running. I will then turn the call over to Steve to review the financials and discuss our outlook.

When I look at the talent and capabilities we have at Wet Seal, our real estate portfolio, the core 16 year-old customer and our competition in the mall, I'm incredibly excited about the potential to return the business to its fast fashion roots, restore comp store sales growth and drive profitability. The company has historically been a strong cash flow generator, and today, we have the resources to invest in critical short-term priority, as well as longer-term growth opportunities, while at the same time, returning value to our shareholders.

At year end, we had $110 million in cash and cash equivalents and short-term investments and no debt. In February, our Board of Directors approved a $25 million share repurchase program, which reflects our confidence in Wet Seal's operating strategy and growth potential, as well as ongoing commitment to create shareholder value. We have a highly disciplined approach to capital allocation. Going forward, you can expect to see us utilize our cash to fund investments that drive returns in addition to value-enhancing share repurchases.

I've always viewed Wet Seal as a pioneer in fast fashion. We knew -- we know who our customer is, and I'm certain we can return the business to its roots quickly. Before I discuss our strategies and key accomplishments thus far, let me briefly recap how the company reached its current inflection point. Beginning in late 2011 and through mid-2012, the business moved away from the Wet Seal's core merchandising tenets. In short, lead times were extended, price points were elevated and assortments were narrowed, and the merchandise was simply not on trend. The company lost focus on its core 16-year-old girl.

Today, with those missteps behind us, we're in the final stages of stabilizing the business and preparing for growth. As a board member since last October, I've had the benefit of working with the management team prior to becoming CEO. During my first few months at the company, I've focused on gaining a more in-depth understanding of Wet Seal's strengths, identifying issues and opportunities and executing quickly. I've been meeting with team members at all levels of the organization; this includes merchant meetings and product reviews, as well as extensive discussions on inventory productivity, operational capabilities and processes. I've also spent a great deal of time in the field, visiting stores and meeting with vendors. Broadly speaking, I have grouped my learnings into 5 areas of strategic focus: number one, corporate culture; number two, product and marketing; number three, inventory management; number four, real estate; and number five, e-commerce.

First, culture. I'm pleased to note that we have a great deal of talent across all levels of the organization. Despite the challenges and the changes in the past year, in particular, the team remains passionate and committed. In today's fast fashion world, it's critical to be nimble and quick, which means we need to inspire an entrepreneurial culture to succeed. We made some organizational changes, including key promotions, which are allowing our team members to play to their strengths. We've eliminated layers and aligned everyone to common goals. These actions are empowering people to make decisions, take responsibility and move quickly.

Next is product and marketing. I cannot emphasize enough how focused we are on product. In fact, we have a maniacal focus on product. The majority of our problems in 2012 were content-driven. Directional changes related to product and brand positioning caused the company to alienate its core customer and give up merchandise margin. Since my arrival in January, I've spent a great deal of time working with vendors and overseeing changes to the assortment. We have a seasoned merchandising team that is really terrific. They're highly motivated. They know who our customer is, and they're excited to win her back.

Our merchants are literally working with the market every day. If you've been visiting our stores in the past few months, hopefully, you will agree that we are getting better on a weekly and daily basis. The merchandise is much more trend-right, and we now have a strong presentation in key categories, from graphic tees, dresses, shorts and denim to footwear and accessories. We're still working to improve our basic knit tops and fashion knit tops business. But today, the majority of our stores look significantly better, and we've only just begun.

The underlying strategy is not complex. We've gone back to our roots. We focused on the core 16-year-old girl. We're delivering the fashion she wants and the quality and the value she expects. We're in the beginning stages of making our refined marketing and visual merchandising playfully disruptive. In fact, everything we do is going to be playfully disruptive. Our products, merchandising, marketing and website will all be focused on grabbing her attention and letting her know that Wet Seal is, once again, a cool place to shop. Our Wet Seal marketing will feature programs and partnerships centered around music, fashion and celebrities. We'll be working with key influencers that resonate with our core girl. We'll also be building upon some of our creative and highly successful promotions, including Saturday Steals and our Wanna Be Next? model search. Most importantly, we need to talk to her from a mobile perspective. In the past, our social media effort has been minimal, so we're stepping up our game, and we view it as a major opportunity.

The third area of focus is inventory management. I just told you that we have a maniacal focus on product. Now I'll tell you that we are obsessive about inventory management. Our inventory turn is at 7x. We have little inventory in our DC and none in our stock rooms. We have reestablished partnerships with many of our quick-source vendors, and we've shifted our open-to-buy strategy, leaving more dollars available for chase opportunities. We're investing in each department strategically, so we can adjust and react to trends very quickly. And we're now supporting this with test and reorder practices in trending fashion categories. And with short lead times ranging from just 1 week to a maximum 4 months, we have the ability to get back into strong sellers or move rapidly into trending categories in a matter of weeks.

Next, I'll discuss real estate. First and foremost, the fleet is in very good shape, and we will not require a significant amount of capital. While our medium priority is to stabilize the business as we prepare for growth, we'll be exploring opportunities outside the traditional mall, including outlet centers, where we can generate higher productivity and profitability. Our plans this year include 15 new outlet malls and 4 mall locations. We'll also invest in capital to remodel a small number of Wet Seal stores when leases come due. Looking out longer term, we believe there's an opportunity to significantly expand our footprint.

The fifth area of focus is e-commerce. Today, Internet sales represent roughly 6% of our total business. Given who our core customer is, there's no reason we cannot quickly bring that up to 10%. Our head of e-commerce was brought in 1 year ago. The business was stabilized under his leadership and started growing during the latter part of 2012. The initiatives he spearheaded are ongoing and continue to drive improvement. First, we're aligning our e-commerce and store shopping experiences to deliver a unified point of view and brand message. We're also implementing multichannel marketing program that encompass our store portfolio, website and mobile application. And finally, we're expanding our e-commerce-only offering, starting with Jr. Plus.

Now I'll turn to Arden B, which represented 15% of our total sales in fiscal 2012. We view this as a work in progress that will require a very small investment to turn the business around. In recent years, the customer was confused by a change in merchandising direction and declining quality. We're going back to the core 28-year-old female customer, delivering the aspirational experience and building on Arden's heritage as a dress destination. Most recently, we started to gain traction in club dresses and tops, and we're beginning to see modest improvement in overall business trend. In terms of real estate, we'll continue to close underperforming stores upon lease expiration, and we'll consider short-term lease extensions in select locations.

Before I turn the call over to Steve, I want to emphasize that we have executed quickly, made a great deal of progress and see strong evidence that our strategies are beginning to positively impact the business. During the past 3 months, we've returned the company to its fast fashion roots, took $5.5 million or $0.06 per share of costs out of the business and developed the plans to drive comp store sales growth and restore profitability. We're in the final stages of stabilizing the business and preparing for growth.

We're now 7 weeks into the quarter. As we indicated in our press release today, we're not immune to the macro factors and weather challenges that affected most retailers during the month of February. That said, we have seen improvement following the difficult parts of the year and believe we will continue to gain traction as we implement the merchandising and marketing strategies I've described. We're in a business that affords us the opportunity to move fast. I arrived 74 days ago, and we were able to start executing right out of the gate, which should allow us to return the business to positive comp territory and begin to drive margin improvement later this year.

With that, I'll ask Steve to review the financials before we open up for Q&A.

Steven H. Benrubi

Thanks, John, and good afternoon, everyone. Turning now to a review of our financial results, net sales for the 14-week fourth quarter were $161.7 million, down about 1% versus the 13-week quarter of last year. Consolidated comparable store sales declined 8.3% in the quarter. On a comp store basis, combined average unit retail declined 2.7% to $9.85. Transactions per store declined 7.8%, and units per transaction were up 1.8%. Combined e-commerce sales in the fourth quarter increased 13.9% versus a year ago.

In the Wet Seal division, fourth quarter net sales were $137.2 million, down 1% versus last year, while comparable store sales declined 9.1%. E-commerce sales at Wet Seal improved 19.5%, reflecting the ongoing refinements and new strategic initiatives John discussed earlier. On a comp store basis, AUR declined 3.2% to $8.91, and transaction count fell 8.3%, while UPT was up 1.8%. At Arden B, net sales were $24.4 million, essentially flat versus the fourth quarter of last year, and comparable store sales were down 3.1%. On a comp store basis, AUR declined 5.5% to $28.33, and transactions were down 2.7%, while UPT was up 5%.

Fourth quarter gross profit came in at $40.1 million compared to $49.6 million last year, while gross margin was 24.8% versus 30.4% a year ago. The year-over-year decline of 560 basis points can be traced to 2 major factors. First, merchandise margin declined 420 basis points, reflecting pressure at Wet Seal, offset by a slight improvement at Arden B, and second, occupancy de-leveraged by 130 basis points. For further perspective, our buying costs were down slightly, while distribution and planning and allocation costs were up marginally.

Selling, general and administrative expense for the quarter was $57.6 million or 35.6% of sales compared to $44.9 million or 27.5% of sales a year ago. Selling expense came in at $37.9 million or 23.5% of sales. That compares to $35.4 million or 21.7% of sales last year. The 180 basis point increase is primarily due to higher store wages and benefits, driven mainly by the overall deleveraging effect of our comparable store sales decline.

General and administrative costs for the quarter totaled $19.7 million or 12.1% of sales compared to $9.4 million or 5.8% of sales a year ago. Approximately $2 million of the increase is attributable to legal fees for employment-related litigation. The balance of that is primarily due to 3 factors: a $6.6 million charge to accrue loss contingencies for several litigation matters, a $500,000 early termination fee related to 2 investment banker retention agreements and a $1.3 million severance charge. As a reminder, at the close of the fourth quarter, we announced a workforce reduction and cost-cutting initiative designed to improve our operational efficiency, better align our workforce to current business needs and reduce overall expenses. These actions are expected to drive $5.5 million in annual cost savings beginning this year, which translates to approximately $0.06 in diluted earnings per share.

Fourth quarter operating loss was $25.5 million compared to operating income of $2.2 million last year. The fourth quarter of 2012 includes an adjustment and charges that are detailed under Exhibit C in our press release issued today. Those include a noncash asset impairment charge, a benefit from the adjustment of professional fees and the loss contingency accrual, severance charges and early termination fees noted above. On a non-GAAP basis, excluding the adjustment and charges, adjusted operating loss in the fourth quarter of 2012 was $9.3 million or 5.8% of sales. This compares to operating income of $4.7 million or 2.9% of sales in the fourth quarter of 2011.

As noted in our press release as well this afternoon, we recorded a noncash provision for income taxes of $71.1 million to establish a valuation allowance against our net deferred income tax assets. Despite our pretax loss in 2012, due to the impact of the valuation allowance, we recognized a provision for income taxes of $60.3 million in Q4 and $42.9 million for the full year. As you know, the valuation allowance has no impact on our ability to utilize loss carryforwards or tax assets in the future.

Net loss in the fourth quarter was $85.8 million or $0.97 per diluted share, which compares to net income of $1.1 million or $0.01 per diluted share in the prior year period. On a non-GAAP basis, adjusted net loss in the fourth quarter of 2012, which excludes the noncash provision for income taxes, as well as the adjustment and charges I described earlier, was $4.8 million or $0.06 per diluted share and is in line with our previously announced guidance. In the fourth quarter of 2011, on a non-GAAP basis, adjusted net income was $2.6 million or $0.03 per diluted share.

Now moving to the balance sheet. Inventories at year end stood at $33.8 million, up 6.1% versus last year. This was in line with our expectations and reflects in part the effect of a 53-week calendar, as well as our strategic decision to take receipt of certain spring goods earlier than in the prior year. Inventory per square foot was up 9.6% versus a year ago, with Wet Seal up 7.2% and Arden B up 31.3%. The company remains in strong financial condition and ended the year with $110 million of cash and equivalents and short-term investments and no debt. In the fourth quarter, cash used in operations was $12.4 million. That includes an incremental $9.6 million used for rent and other landlord costs, which would typically have been paid during the third quarter but shifted due to the timing of the fourth quarter calendar.

Capital expenditures totaled $3.6 million in the fourth quarter and $20.4 million for the full year. Of that amount, we deployed approximately $2 million in the fourth quarter and $15 million for the full year toward new stores and remodels. On a net basis, including tenant allowance, capital spending was $3.5 million in Q4 and $18.1 million for the full year.

Depreciation expense totaled $4 million in the fourth quarter and $17.5 million in fiscal year 2012. Capital expenditures in fiscal 2013 are planned to be in the range of $22 million to $24 million, or $20 million to $22 million net of tenant allowances. Of this, approximately $16 million to $17 million, or $14 million to $15 million net of tenant allowances, is for new stores, remodels and relocations. Our new store opening plans call for 19 Wet Seal locations this year, principally in outlet centers where, as John noted, productivity levels are higher. We also plan to close approximately 14 to 18 Wet Seal stores and 9 Arden B locations upon lease expirations. Additionally, we have identified approximately 20 to 24 Wet Seal locations for remodel this year in connection with lease renewals.

Now I'll turn to the financial guidance for the first quarter of 2013. Our expectations are as follows: net sales in the range of $135 million to $139 million; a comparable store sales decline in the mid-single digits; gross margin in the range of 26.2% to 27.7%; SG&A between 29.6% and 30.2% of sales; an operating loss between $2.7 million and $5.4 million; and lastly, we expect to report a net loss in the range of $0.03 to $0.06 per diluted share. This includes an estimated $0.02 to $0.03 per diluted share resulting from incremental legal fees regarding employment-related matters that we expect to incur versus the prior year.

Thanks for your attention this afternoon, and now I'll ask the operator to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Jeff Van Sinderen of B. Riley.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

I guess my first question really pertains to inventory on a per square foot basis. I think you said inventory was up total 9% if I caught that right. I think you said it was up, I don't know, high single digits at Wet Seal, and then Arden, if I caught it, you said was up 30% per foot, or did I mishear that?

Steven H. Benrubi

No, you heard that correct, Jeff, and especially at Arden, that was a function of the timing of the year-end date. That last 53rd week is actually a critical receipt week historically, for Arden, for early spring, so it came in this year versus not last. And the inventory levels in Arden on a per foot basis have moderated considerably. They're still up but more in the high-single-digit category as opposed to 31% right now. And they're where we want them to be.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay. So essentially, it was really -- the reason inventory per foot versus native comp guidance is really just a pull forward of early receipts in the 53rd week? Is that...

Steven H. Benrubi

Yes, it's timing, and then also, the Arden business did make progress. Of course, in the January period, we had an up 22% comp. Even with New Year's shift out of there, we were comping positive in the subsequent weeks of January. So we feel good about the balance of inventory and trajectory there.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay, good. And then, John, maybe you can talk a little bit more about your e-comm strategy. I know you sort of touched on that in your prepared comments, sort of what your strategic initiatives are there this year?

John D. Goodman

Yes, I think e-commerce is a very important strategy for us. If you think about it today, it's 6% of our business. We really think we can get to 10% sooner than later in terms of where we feel the business needs to be. We see there's a really big growth potential, including Jr. Plus, which we have online currently and is performing very well.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay, good. And then, John, at this point, have you officially decided whether or not you're hiring a CMO? Maybe you can just update us on your thinking on that and then also the leadership at Arden, what the status is there.

John D. Goodman

In terms of hiring a CMO, we are looking at the team that we have today. I'm very confident with Debbie and Kim leading the merchandising efforts today. I'm working very closely with them and will continue to do such. So I feel confident with Debbie and Kim and their performances and where the business is going and how they interact with the merchants currently. In terms of Arden, as we've talked about before, it is a work in progress, and we're continuing to look at how to make that business better and what the needs of the business are and looking at all aspects of that business. So I would say we're continuing to evaluate the Arden B business, and we're comfortable where the Wet Seal business is trending.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay. And then in your prepared comments, you also said that you're seeing improvement in the business. Maybe you can just give us more specifics on that, what metrics are improving. And then do you mean improvement sequentially? I think that's what I assumed. Or do you mean year-over-year? And then any sense of when you think we might be returning to positive comps in a full quarter?

John D. Goodman

Yes, as we talked about, obviously, the macroeconomic conditions and some of the weather issues that have occurred during -- I sort of hate talking about weather, but some of those are really dramatic, what's occurred in the past 6 weeks. So if you look at our business going forward, we're really getting some good traction in some of the markets that have not had weather issues. And we're encouraged by that and the new product that is coming in and the sell-through and the performance of those products. As we said earlier in the comments, I really feel like as we're stabilizing, we're near stabilizing the business and prepared to grow, and we feel very comfortable that we will start to see positive comp territory, certainty as we go into the back half of the year.

Operator

The next question is from Eric Beder of Brean Capital.

Eric M. Beder - Brean Capital LLC, Research Division

Could you talk a little bit about the outlet stores that you're opening now? Are you going to be selling the same products in the mall in those outlet stores? And what should we be thinking about in terms of the size and maybe potential returns for something like that?

John D. Goodman

In terms of the outlet business, we really see it as an opportunity. We currently have about 8 outlet stores today, so we really see that as an opportunity to grow the business. In terms of looking at the product and the presentation of that product and the composition of the product, we will have differentiated product, as well as continue to find the right balance of promotional cadence for the outlet business. We do see it as an opportunistic growth vehicle for us, and it has performed above the fleet in years past.

Steven H. Benrubi

Yes. In terms of the economics of outlet stores, I mean the build costs are clearly less expensive to do the store. Productivity, John talked about the small number that we have today. They actually are highly productive stores. That combination can get us cash on cash returns that outperform traditional mall locations. So we're clearly being opportunistic about how we're opening stores this year by doing it in outlet channels. They aren't going to be, per se, clearance centers. Our model's not really geared toward moving product around the chain. It's about, in terms of the malls, selling the product that's there, and in the outlet centers, putting forth compelling promotional messaging. But it's going to reflect the Wet Seal brand.

Eric M. Beder - Brean Capital LLC, Research Division

Okay. And have you -- what's the thought process in terms of eventually maybe opening some strip mall centers? Have you thought about that?

John D. Goodman

We look at the whole opportunity for Wet Seal. Really, our first goal right now is to stabilize the business and begin to grow. We do see other opportunities outside of the traditional mall that we'll be looking at in future quarters and as we go further. But for right now, we really see the opportunity of fixing the business, building an outlet business and moving from that point on.

Eric M. Beder - Brean Capital LLC, Research Division

I guess the question is you've had -- last 1.5 years was very rough for the company. You were trying to get that girl in and she has not been coming in. How do you look at the merchandising in the front of the store in terms of that, promotions to get her into the store?

John D. Goodman

Well, the good news is the girl is starting to come in. And that's -- the biggest challenge we have is becoming relevant again. And obviously, getting the right product is key for that. The second piece of that is really how do we, as I call it, playfully disrupt her. And that's really what we're doing right now in terms of our windows. If you visited our stores recently, you'd see the windows, you'd see the front entryway. The company introduced last year, Saturday Steals, and we now have it every single week. So every single Saturday, that girl is seeing new product or existing product that we're really highlighting for her. So really, the front of the store, as well as the window, has become a very, very important part of that process. Then once we get her in the store, we really convert her by a Saturday Steal, but also, she's starting to see other product in the store that she likes and it's beginning to work.

Eric M. Beder - Brean Capital LLC, Research Division

Prior management had some issues with some of the inner wear and some of the underwear. What is your thought process on the categories, and are there certain categories that should be there that aren't or certain categories that need to be deemphasized?

John D. Goodman

Well, in terms of intimate apparel today, we really see that as an opportunity for us, but I think it has to be in the right vein for our girl who's age 16. That's sort of our sweet spot. So we really want to make sure as we look at the assortment overall, that we're really speaking to that girl. And obviously, she errs on the younger side of 16, so we really want to keep her and have things that are important for her, that she relates to and that is trend-right for that girl.

Eric M. Beder - Brean Capital LLC, Research Division

And are there any other categories you think you really want to expand or contract right now?

John D. Goodman

Well, I think the knit tops business, as they've communicated during the course of the past year, as well as it continues to be an issue for us, the fashion knit tops. We've made some changes there, and we really feel like we're positioned to really build that business in the right way. It's been a difficult business for us. The wovens business, woven tops business has been strong. Our bottoms business continues to be strong. We really -- fashion knit tops has been our biggest issue to date and we have taken the steps to correct that business. The good news is most of the lead times in those tops are not that long, so we're able to change the assortment pretty quickly.

Operator

[Operator Instructions] The next question is from Edward Yruma of KeyBanc.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Really quickly on the valuation allowance. Does this imply then that you're not expecting to generate any net income in the foreseeable future and that's why you took the allowance against the deferred tax asset?

Steven H. Benrubi

No, really, the analysis of that is from the accounting standpoint, fairly mechanical in terms of it's more of a look back, more specifically a look back at the prior 3-year period and whether you generated a cumulative income or not. And if you didn't, which in our case, given the charges and everything in '12, we did not. Unless you've got immediate, compelling evidence that, that's completely turned around, the conclusion is you have to put the allowance on the books. And so it's certainly not a reflection of our point of view about turning the business. I don't know if you recall or have been around us long enough to know, but a few years ago, we used to have an allowance and we were able to reverse that after generating several years straight of income. And clearly, that's what we're hoping to do down the road here. And the last point, just to be clear, is this has no impact on our ability to actually utilize those assets, which is primarily an NOL. I mean we can use it, it's just not being recognized on the books right now.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Got you. John, you indicated that you felt like some incremental investment or attention would be necessary to turn Arden B around. I guess could you characterize some of that, either from a timing perspective or from an open expense perspective?

John D. Goodman

No, I said earlier, it's a modest -- it's modest or very little in terms of what the investment will be for Arden B. We've taken some of the steps right now from a visual presentation, looking at some of the imagery, as well as enhancing the store experience by lowering the walls. We used to merchandise all the way to the ceiling. We've now brought the product down so that woman can reach up and get the product as opposed to having her reach up or ask for help up in the -- so I think if you look going forward, we're really going to do modest or little investment in Arden B. Our priority right now is, obviously, focusing on fixing the Wet Seal business and doing those things. But we feel like we've gotten some good traction with Arden B and we look for that to continue during the course of the year.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Got you. And the final question. John, as you've gone to meet with the vendors, you've had a number of changes in merchandise strategy under previous leadership. I guess, what's their appetite or willingness to accommodate kind of a return to your fast fashion roots? And kind of how quickly is that new merchandise coming into stores?

John D. Goodman

Yes. I think that's a great question, and the good news is the vendor community is very excited about us going back to what we did well. I think they were very confused the past couple of years, and are very optimistic about our future and our ability to work with them. They've been great. Our merchants are in San Pedro every single Wednesday now, they're there. They're working with the market. They're in market in New York. They really are building -- they've already had a great relationship, it's now just going back and building it back with our key vendors. So they're excited about the opportunity and the potential of Wet Seal, and they certainly know when we talk to that 16-year-old girl in the sweet spot, that we've had success in the past.

Operator

The next question is from Chris Donnelly of Pacific Rock Capital.

Christopher Thomas Donnelly - Pacific Rock Capital, LLC

As it relates to cash, where do you see that kind of bottoming out from an operational standpoint x the share buyback?

Steven H. Benrubi

Well, I mean, what we're focusing on obviously, number one, is getting back to a positive free cash flow generation in the business. And the key factors that'll get us there, one is comp store sales positive, even modestly. Because given the cost we took out of the business at year end, doesn't take much to start leveraging again in the business. But more importantly, getting the merchandise margin quality back. We gave up several hundred basis points there that led to, in the third quarter, we were down almost 800 basis points year-over-year in margin. We were down 560 in the fourth quarter, and you can see in our guide in Q1, we're looking to make further progress to narrow that in Q1. So those are the drivers to getting it back. I'm not going to quote a number to you, it's a function of how quickly we turn the business, and that's our top priority, really, is to level off at least our cash, free cash and then get it going positive again later on.

Christopher Thomas Donnelly - Pacific Rock Capital, LLC

Okay. And in terms of -- I may have missed this, but on a dollar per square footage basis, where did we end the year?

Steven H. Benrubi

I'm assuming -- are you talking about the inventory position?

Christopher Thomas Donnelly - Pacific Rock Capital, LLC

Yes, on the inventory.

Steven H. Benrubi

Yes, yes. A 6.1% increase year-over-year. I spoke to this a bit earlier. Arden B was up, because they had a significant timing difference in receipts for early spring, they were up 30%, just over 30% on a per foot basis in inventory. But that's normalized down now to a high single-digit, right around 10%, I think, year-over-year, which is where we want them to be. And then Wet Seal in that mid-single-digit positive. Something that we've done more consciously in the last year or so, I'd say, is ensuring that from a basic denim standpoint, we have the inventory that we have to have to ensure we're in size and we're not missing sales there. It's a replenished product, it doesn't have the fashion risk of other parts of the store. And that weighs into some of the inventory metrics as a conscious decision we've made.

Christopher Thomas Donnelly - Pacific Rock Capital, LLC

And then as it relates to the sales per square foot, where did that end up?

Steven H. Benrubi

Sales per square foot, at Wet Seal were, I think, $245 a foot on the year; Arden B, just under $300 a foot for the full year.

Christopher Thomas Donnelly - Pacific Rock Capital, LLC

Can you talk about those levels in comparison to past peaks and your confidence in getting back there and what that would mean for the gross and operating margins?

Steven H. Benrubi

Absolutely. We ran -- prior to 2012, we were running for the 3 years before that, at $270 a foot at Wet Seal, give or take $1. It was running very consistently productive at that level. And we were doing it with a healthy merchandise margin. I think that those go hand-in-hand. We were selling more because we had better content and getting better quality. And that was translating to a mid-single-digit operating margin for the business. And those kind of metrics, the infrastructure, cost that we've rationalized gets us to a place where we get back to those types of levels of productivity and margin quality, it's going to translate to that kind of operating margin performance. And given Wet Seal's the 85% plus of the business, that's where it has to happen. And it compares lastly, $321 a foot is where we peaked in 2006. I think on our radar, let's focus on restoring '11 and prior, recent history, productivity and then build from there.

Christopher Thomas Donnelly - Pacific Rock Capital, LLC

Great. And my final question, John, if you could just talk about your decision to take over the title of CEO, your commitment to the company as it relates to your recent share purchase?

John D. Goodman

Yes. I was excited. I said earlier in different meetings, I'm very excited about working with the current board. I feel really good about the opportunity that they've given me and certainly, the opportunity for Wet Seal. And from a purchase point of view, I really felt like I was prepared to put my own money in because I really believe in what we're doing and where the business can end and what the potential is. So I was able to put my own money in to speak about the confidence that I have with the team here, as well as the confidence to turn the business around.

Operator

The next question is from Liz Pierce of Ascendiant Capital.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

So in terms of, John, on kind of big picture for Wet Seal in the competitive landscape, I mean just what's your sense -- and it kind of relates to the question Chris was asking. Are there any barriers to getting back to -- on an operating margin for Wet Seal kind of above that mid-single-digit level?

John D. Goodman

Yes, I think our ability to communicate effectively with that girl is the most important thing that we need to do. We really feel like from a product perspective, we've made some good strides and we will continue to do that during the course of the year. I think the biggest challenge we have is really to articulate to that girl, why she should shop at Wet Seal and Wet Seal is cool because. And what that means is how do we entice her, how do we talk to her from a digital standpoint, how do we influence her from either music or fashion or styles or things we're doing, and it's not just about promotions and doing things like that. It's about becoming part of her and in terms of how we appear to her. So I think that is a challenge that we have and certainly, the opportunity. And as compared to our competition, I think we have a place where we can carve out our niche for our 16-year-old girl, and as I said, more on the younger side, and win with her.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

So when you -- that's helpful. Are you planning to like take a group of test stores and try certain things by region, by location? Or you think you'll just take one broad stroke on some of the digital media things? Just...

John D. Goodman

Yes. I think as you look at it today, we are testing. We now test amount of products every single week we're testing in certain test stores to get a read and react. As you know, our lead times are anywhere from 1 week to 4 months maximum. So our ability to test, read and react, and we have a template now that really shows what worked and what didn't work, what colors work. And going forward, you'll see that as we strategically go after by region, by district, by metro area, where we can influence that girl. And it's also around what music is influencing her. So we're going to start really looking at each of the districts and the regions, as well as the testing that we're doing from a merchandising standpoint, to really speak to that girl in a particular area. But there will also be consistent themes. A great style is a great style, and we've seen a lot of that where we get significant sell-throughs across the country on great product when we have it. So I think that will be very important for us.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

Okay, good. And then in terms of Arden B, recognizing that, obviously, it's a small percent of the total business. But what is your -- or is it perhaps too early, kind of the vision? There's been a lot of kind of false starts, if you will, in terms of being a lifestyle brand or is it more of an occasion-driven brand? Is there anything that you can kind of tell us like overarching feel that you have about whether there's white space in this sector, et cetera?

John D. Goodman

Well, I do believe there's white space in the sector, there's no question. Arden B, we are working on that strategy. I will tell you that the business from a standpoint of club tops and club dresses, things that she likes about us. She's a 28-year-old woman, and we really are able to talk to her in a way that she likes -- some of it's formfitting clothing and things like that, that I think will be very important for a girl. In terms of the strategy, we really are looking at all different aspects of that business, and we will be able to communicate with you really next quarter about where we see the potential for Arden B. But we are encouraged about when we went back to our roots of "when Arden B did well" with the club tops, with the dresses, some of the key accessory categories that we can go after and start building that business back.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

Okay, great. And then, Steve, I'm not sure if you mentioned this, but could you tell us what your kind of lease renewal outlook, what's coming up in the next couple of years?

Steven H. Benrubi

Sure. We've got a little over 80 leases that are up for renewal in 2013, and going a little off the top right now, but I think around 30, mid-30s in 2014 that are up for renewal. We do have a number of deals that, over time, we've done some shorter-term leases that come up every couple of years, for instance. So that's some of what's in the 80% that's in front of us in '13.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

And then you said you're going to do about, what, 24 remodels this year?

Steven H. Benrubi

Yes, all in the Wet Seal side.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

On the wet -- and are these going to be major remodels? Are they more like cosmetic, changing fixturing, packaging?

Steven H. Benrubi

Yes, these -- that's a good question. These are the fall remodels we're referring to and these are the cases where we're renewing a lease for a full 10-year period. For a couple of reasons, we're going to do those stores. One, we're making another 10-year financial commitment and the stores obviously need the attention at that point; and two, frankly, the landlords will require it when you go out for a long lease. We want to put our best foot forward. We're also, in the capital plan, we have some dollars to be able to do some refreshing of some of the stores that we've done in recent years where, I think as John has best described it well in the last couple of years, we had a prototype where some of the wallpapering and paint in the store was fighting a little bit with the merchandise, and toning down the store and neutralizing to let the merchandise speak. There's some dollars to do some refreshes and that's a far smaller investment. That's, I won't just say a coat of paint, but it's a minor bit of work that goes into doing that.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

Right. And it seems like at least the stores that I'm seeing out here, you're bringing more merchandise off the wall, putting more visuals. Is that really kind of chain-wide right now?

John D. Goodman

Absolutely. And that, you should see in every store you go to. We really -- as we did in Arden B, but first started in Wet Seal, bringing the product down to eye level, creating visuals, doing much more imagery, much more visual techniques above so that the customer as well as the sales associate doesn't need to have the pole to get the product from the ceiling. And I think that's really important in how the aesthetics of the store look. It's also our ability to turn the product faster, and we were able to do this. And that's -- it's been very, very positive, and you should see that in every store across the country.

Elizabeth O. Pierce - Ascendiant Capital Markets LLC, Research Division

So but, John, does that mean you need different fixtures on the floor because you're bringing -- are you going to take out just the unit – will the unit inventory come down so it's not crowded?

John D. Goodman

Yes, we're looking at that in terms of, we like some of the fixturing. We're going to look at fixturing just in course just to see what makes sense from a capacity standpoint. But we feel very comfortable right now with the amount of inventory we have, even when we took it down off the walls, that we're in good shape there. I think there are certain times as peak is right now, we're going into Easter. So we are peaking in terms of our spring season from an inventory perspective. But as you go through the fits and starts and going to the fourth quarter, we'll really be able to evaluate how quickly we're turning the goods and how much inventory those stores need to have.

Operator

The next question is from Steph Wissink of Piper Jaffray.

Maria C. Vizuete - Piper Jaffray Companies, Research Division

This is actually Maria Vizuete on for Steph. I'm just wondering if you can talk a little bit about the current pricing strategy at both divisions and if you feel comfortable where that's at currently.

John D. Goodman

Yes, I absolutely, in terms of the pricing, I feel very, very good. In Wet Seal specifically, I think we have a great mix of price to sell, as well as promotional cadence that we do. It is a great balance in terms of the profitability. I don't think I need to make wholesale changes. If anything, last year, we raised the prices of the product in Wet Seal. And I think we've gone back to when we were at our best fast fashion roots. If you think about, the key word here is value for that girl. And as I said, she's a 16 -year-old girl who's looking for value, clothing, and giving her the price that she expects and the quality that she's looking for. So in Wet Seal, we feel very good about the pricing. I think in Arden B, one of the challenges we had is some of the quality wasn't where it needed to be with the price points. And now that's something we're working on currently, is making sure that when we have certain products, the quality speaks to that price. We shouldn't be selling cheap quality goods at 3x the price everybody else is. And we've corrected a lot of that going forward because I think that's been an issue for Arden in the past.

Maria C. Vizuete - Piper Jaffray Companies, Research Division

Great. And then, John, just commenting from a fresh perspective, are there any additional pockets of variable expenses that you think can be reduced or eliminated over time?

Steven H. Benrubi

This is Steve, I'll speak to that. We did -- we took a lot of infrastructure cost out of the organization at the end of the fiscal year. We're a lean team now, we're set up in a way that facilitates quick decision-making, flat management structure. So we think we're right for the type of business we're in, but that's not to say that we won't always look for cost opportunities and ways to be more efficient. But we feel good about the move that we made and where it took us.

Maria C. Vizuete - Piper Jaffray Companies, Research Division

And then lastly, can you just update us on the longer-term store targets for both divisions?

Steven H. Benrubi

We've long talked about Wet Seal as being a chain that could have 700 to 750 stores in the U.S. And I think we're evaluating where the best venues for those locations are. The fact that we're doing some more outlet stores speaks to the success we've had in the small handful of those that we've done today. You may have heard earlier some conversation about off-mall also as a venue that we should be exploring. So that's still a work in process to revisit, but in terms of the -- that magnitude of store count, be able to grow the business that way, maybe through some different venues than we might have targeted in the past, we feel like probably we'll head in that direction.

Operator

We have no further questions in queue at this time. I would like to turn the floor back over to management for any additional remarks.

John D. Goodman

Well, thank you, all, for listening in today. We're very excited about the progress and we look forward to talking to you next quarter. So have a good day. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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