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Executives

Ed Thomas - President & Chief Executive Officer

Steve Benrubi - Chief Financial Officer

Jennifer McEntee - Vice President of Financial Planning & Analysis

Analysts

Paul Lejuez - Credit Suisse

Elizabeth Pierce - Roth Capital Partners

Eric Beder - Brean Murray

Sam Panella - Raymond James

Elizabeth Montogomery - Longbow Research

Jeff Van Sinderen - B. Riley & Company

Anna Andreeva - JP Morgan

The Wet Seal Inc. (WTSLA) Q2 2009 Earnings Call August 20, 2009 4:30 PM ET

Operator

Good day ladies and gentlemen. Welcome to Wet Seal Incorporated second quarter 2009 earnings conference call. At this time for opening remarks and opening introductions, I would like to turn the conference over to Mr. Ed Thomas, President and Chief Executive Officer.

Edmond Thomas

Good afternoon everyone. Thank you for joining us today to discuss our second quarter fiscal 2009 results. With me are Steve Benrubi, our Chief Financial Officer and Jennifer McEntee, our Vice President of Financial Planning & Analysis. Before we begin Jen will provide our Safe Harbor statement. Jen.

Jennifer McEntee

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 risks, uncertainties and assumptions about our company, economic conditions and 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 31, 2009 and our Form 10-Q for the fiscal quarter ended May 2, 2009, as filed with the Securities and Exchange Commission.

On today’s call we will make references to net income and earnings per diluted share for the second quarter of 2009 and 2008 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 are used by management can be obtained from the company’s website at www.wetsealinc.com. Ed.

Ed Thomas

During the second quarter, we continue to manage conservatively through a difficult retail environment. Although we are not pleased with our second quarter results overall, we have seen times of progress in both of our division especially at Arden B and we began the second half of 2009 with the cautious optimism that we can improve upon our results from the first half of the year.

At Wet Seal, we tightly controlled inventories during the quarter as we progress towards correcting mistakes in our assortment and positioning the business for the back to school season. As we previously said at the beginning of the second quarter, we were in the process of addressing inventory mix issues at Wet Seal that required corrections and indeed we made significant progress on this front.

Nonetheless, sales in merchandise margin performance were challenged along the way. Regarding Arden B, the second quarter marked continued improvement in the profitability of this business with operating income that exceeded both the prior year second quarter and the current year first quarter results.

While our conservative inventory investment in our lower price merchandizing model likely constrained comparable store sales results, this has also led to segment operating income of nearly 12% of sales in the first half signaling a return to profitability for this division after several years of significant losses.

We have gained according with the new Arden B strategy, and now have confidence to invest in higher inventory levels in an effort to facilitate consistent comparable store sales growth. Also during the quarter, we continue to generate decreases in our corporate G&A expenses.

As you may know, we begin focusing on cost reductions in G&A and other areas of our business almost two years ago, resulting in several million dollars of savings in fiscal 2008. Through additional staff reductions in January 2009, and continued cost discipline, we further reduced G&A in the second quarter of this year versus the prior year quarter.

In addition, our balance sheet remains very healthy. Our cash balance was $144 million at the end of the quarter with minimal long-term debt. We continue to view cash preservation as a leading priority, and inventory levels declined 14.6% to $38 million in the second quarter with both divisions conservatively positioned at quarter end.

Now turning to our division results. At Wet Seal, we experienced 11.9% decline in comparable store sales in the second quarter. The retail environment remained challenging and highly promotional. Nonetheless we believe much of this decline resulted from our own assortment weaknesses, primarily excess levels of basic tops in certain accessories in light positions and fashion tops and dresses.

During the course of the second quarter we rebalanced our tops assortment between fashion and basics and began to generate significantly improved results in that category as July progressed. We also worked with core performing accessory categories primarily scarves and jewelry which negatively affected gross margin in the second quarter.

We have very little overhang in these categories heading into the second half. This progress better positions Wet Seal going into the third quarter, but there are still further opportunities for improvement that we are addressing.

We will continue to build inventories in key ready-to-wear categories including fall dresses and outerwear, and in accessories such as jewelry that should help these categories complement sales improvements we’ve recently in tops and denim bottoms.

As we announced during July, we recently brought two new and very experienced divisional merchandise managers to the Wet Seal leadership team, Kim Bajrech and Debbie Shinn. Kim and Debbie are replacing two former merchandize managers who recently left the company.

Kim returns to Wet Seal after having served in a similar role thought my prior tenure with the company in the ‘90s and Debbie come to us with nearly 30 years of general merchandizing leadership experience. I’m confident that they will provide tremendous support to Maria as we work to improve consistency in the division’s merchandize assortments, and sales as margin resolves.

Regarding systems initiatives, we remain on track with the rollout of markdown optimization at Wet Seal, which should enable us to further improve markdown. We now have about one-third of our Wet Seal business supported by this system and expect to rollout completion by the end of September. We also plan to have our size optimization software implemented before the holiday season which will enable us to better align our size offerings to our Wet Seal customer’s need.

We are also currently pivoting updated point of sale systems which should improve transaction processing efficiency in our stores, a key opportunity in our high transaction volumes business. Looking further out, we will deploy an updated retail merchandizing system sometime in 2010 which will improve our merchandizing decision to support an inventory management.

These system enhancements are all merchandizing, and operationally focused with each supporting our efforts to improve sales and operating margins, and we are managing these systems improvements carefully to ensure no significant disruptions in our business.

In terms of the Wet Seal real estate portfolio, we opened six Wet Seal stores and remodeled 10 Wet Seal stores in the second quarter of which all now have redesigned fixture packages, in-store firms with our new store prototype. We now expect 32 Wet Seal store remodels with the new store prototype design, and fixture package will be completed during fiscal 2009.

This is down from our prior estimate of 40 stores this year, due to timing, shifts and lease renewal negotiation. On year-end, approximately 18% of the Wet Seal fleet will be in the new format. This new prototype allows a more efficient and [shoppable] presentation of the higher number of units we merchandise in our Wet Seal stores and earlier on has demonstrated an opportunity to drive sales improvements.

We have acted decisively to rebound from our disappointing second quarter results of Wet Seal. We believe these merchandise and corrections and software implementations combined with our ongoing transition to a new store prototype fixture package will improve store level productivity at Wet Seal in the second half of 2009 and beyond. That said we will continue to manage the business and inventory positions conservatively through the ongoing economic challenges.

Turning to our Arden B business, we continue to be very pleased with the progress we have made in the turnaround at Arden B. We have instituted many changes at this division over the last 18 months. We significantly cut the size and cost structure of the Arden B merchandising organization. We reduced the in-house design activities and we have evolved product development and sourcing to include greater collaboration with our merchandised suppliers making us much faster to market in the process.

During the first half of 2009, these changes have paid off. For the second quarter we significantly increased Arden B division’s operating income which rose to $3.3 million or 13.1% of net sales versus operating income of $1 million or 3.6% of net sales in the second quarter of last year.

This represented our second consecutive quarter with a strong operating income rate. This also add to our first half operating margin of $5.8 million, or 11.9% of sales, a vast improvement over our proximate breakeven results in last year’s first half.

Since converting to a lower price merchandising strategy at the beginning of this year, we have generated a year-over-year increase in transactions of nearly 30%. We continued to believe that much of this increase is coming from new customers to Arden B demonstrating we are regaining our image as a differentiated young contemporary retailer that offers excellent fashion at the right price.

Our customers want fashionable trend looks, but not at a premier price tag and Arden B aligns perfectly with this trend. We have cautiously built inventory levels at Arden B with units per square foot up approximately 20% of the prior year, at most times during the first half. All along we had monitored transaction volume improvement and AUR trends to evaluate the proficiency of this increase.

Our measured approach led to major improvements and regular price selling in merchandised margins at Arden B which are the biggest contributing factors in the division’s return to profitability. By earning on the side of caution, we also know that we have challenged comparable store sales results at Arden B.

While we generated positive comps in April and May due to much higher than anticipated swelters and dresses, fashion tops and other key categories. These strong sales results combined with our considerable inventory management led to right inventory positions in volume driving categories in the subsequent tier months. With experience came under our strategy we are now confident that we should increase the inventory unit volumes further at Arden B.

We believe this will provide opportunity for more consistent comparable store sales growth without sacrificing the benefits we have achieved from significantly improving regular price volume and merchandized margins. Given our continued improvement in Arden B, we also have modified plans to close stores of most Arden B lease explorations; instead we now intend to renew lease business we can obtain attractive lease terms.

We are not however at a point where we plan to open new Arden B stores although we did reopen one recently closed store during the quarter after negotiating more favorable restructures. With respect to both of our operating divisions we will continue to monitor the overall real estate and leasing environment to guide further growth plans.

We remain conservative in our real estate strategy looking to open Wet Sales stores only in situations where we are confident we can generate strong return on investment even in a tough market. As I have mentioned before there are approximately 100 Arden B malls in which we previously had Wet Seal stores and which have been among our highest performing locations.

Many of our 2009 store openings have been in these models and we have seen encouraging sales results today. We look forward to reopening Wet Seal stores in more of these malls at some point. At this movement we expect to open 17 new Wet Seal stores this year. We now plan to close our 16 Wet Seal stores and our Arden B stores which will result in nominal store count change if any in fiscal 2009.

We had not yet established to our growth plans beyond 2009, but we remain convinced that long-term opportunity exists or between 700 to 750 domestic Wet Seal stores and assuming we sustained recent improvements between 200 and 250 domestic Arden B stores.

In conclusion, we will continue to move forward with initiatives to increase store productivity and improve profitability at both divisions through systems implementation, operational improvements and enhanced marketing program. At the same time, we will maintain a healthy balance sheet through careful cost controls and conservative capital spending to position the company for further growth when we decide the time as well.

With that I will turn the call over to Steve who will discuss our second quarter result and introduce our third quarter 2009 outlook in greater detail. Steve.

Steve Benrubi

Thanks Ed. Consolidated sales for the second quarter ended August 1, 2009, were $136.4 million, compared to net sales of $149.1 million for the second quarter ended August 2, 2008. Sales included a $1.2 million breakage benefit related to unredeemed gift cards and sales credits. The effect of the breakage benefit is not included in comparable store sales results.

Comparable store sales for the current year quarter decreased 10.6%. The company reported a 4.4% comp store sales decrease in the prior year quarter. On a comp store basis, our second quarter combined transaction count per store decreased 2.2%. Average unit retail in the second quarter decreased 15.4% to $8.89 while our average number of units per transaction increased 9.4%.

During the second quarter internet sales increased by 12.7% as compared to the same period last year. Net sales in the Wet Seal division were $111.5 million as compared to $121.7 million in the prior year second quarter. Comp store sales decreased 11.9%. Comparable store sales in last year’s second quarter decreased 1.8%. The Wet Seal division net sales in this year’s second quarter included breakage benefit of $800,000.

Net sales in the Arden B division totaled $24.8 million as compared to $27.4 million in the second quarter last year. Comp store sales decreased 4.1% for Arden B. Comparable stores sales in last year’s second quarter decreased 13.8%. The Arden B division net sales in this year’s second quarter included breakage benefit of $400,000.

For the quarter, excluding the impact of the $1.2 million breakage benefit, gross profit was $38 million, a rate of 28.1% as compared to $52 million or 34.9% rate in last year’s second quarter. The 680 basis point decrease in gross margin reflected a 490 basis point decrease in merchandise margins with a significant decline in Wet Seal merchandise margins partially offset by an improvement in Arden B.

In addition, we had 230 basis points of deleveraging of occupancy costs due to the comparable store sales decline. This was partially offset by a reduction in buying and distribution costs primarily associated with the eliminative positions from the restructuring of the Arden B buying and design organization and operational efficiencies in our distribution function.

Selling, general, and administrative expense for the quarter was $34.3 million, or 25.4% of net sales adjusted for the breakage benefit, as compared to $39.9 million or 26.8% of net sales in the same period last year.

Selling expenses, one of two components of SG&A $28.2 million in the quarter or 20.9% of adjusted net sales as compared to $32 million or 21.5% of net sales in last year’s second quarter, the 11.8% decrease in selling expense was primarily due to a decrease in store payroll and benefits, a reduction in advertising and marketing expenditures and lower merchandise delivery costs.

General and administrative cost totaled $6.1 million or 4.5% of adjusted net sales as compared to $7.9 million or 5.3% of net sales in last year’s second quarter. The decline in G&A was primarily due to reduced corporate wages and stock compensation expense as well as the $400,000 credit in the current year quarter to reverse previously accrued incentive compensation due to performance below bonus targets.

We recorded a $1.6 million non-cash asset impairment charge in the second quarter related to assets for certain Wet Seal stores where we do not fully future cash flows will be sufficient to realize the carrying value. Operating income for the second quarter adjusted for the breakage benefit and the asset impairment charge was $3.6 million or 2.7% of adjusted net sales compared to operating income adjusted for a $300,000 asset impairment charge of $12.1 million or 8.1% of net sales for the same period last year.

Operating income in the Wet Seal division adjusted for the items noted about was $6.8 million in the second quarter compared to adjusted operating income of $18.4 million for the same period last year. Adjusted operating margin was 6.1% in the second quarter as compared to 15.1% in the same quarter last year for Wet Seal.

Operating income in the Arden B division adjusted for the breakage benefit was $2.9 million or 11.8% of adjusted net sales in the second quarter, compared to operating income of $1 million, or 3.6% of net sales for the same period last year. Interest expense in the quarter was $114,000 as compared to $1.5 million in the same period last year.

Interest expense in the second quarter of last year included a $1.9 million charge related to the conversion of our secured convertible notes. The effective tax rate was 2.5% for the quarter as compared to 1.7% in last year second quarter. We now estimate our annual effective tax rate will be 3%, down slightly from our estimate of 3.3% in the first quarter.

As we previously reported in 2004, we established a 100% tax valuation allowance in accordance with FAS 109 accounting for income taxes which requires the differed tax assets be reduced by evaluation allowance if it is more likely than not, that some or all differed tax assets will not be realized in the foreseeable future.

We continue to maintain the valuation allowance. Our differed tax assets consist principally of net operating loss carry forward to NOLs. These NOLs do not begin to expire until the year 2023. We begin fiscal 2009 with approximately $118 million of federal NOL carry forward available to offset taxable income in 2009 and thereafter, subject to certain annual limits based on the provisions of Section 382 of the Internal Revenue Code.

Subject to potential further adjustment, we believe NOL carry forwards available will be sufficient to offset all reasonably foreseeable federal, regular taxable income if any in fiscal 2009.

Accordingly, if we were to generate taxable income in 2009, we forecast an effective income tax rate of 3% related to a limited portion of federal alternative minimum taxes that cannot be offset by NOL carry forwards as well as income taxes in the State of California, which cannot be offset by NOLs and certain other state income taxes.

In addition, if we generate taxable income in 2009 we may determine that our tax valuation allowance is no longer necessary and if so will record a significant credit to our provision for income taxes to a limiting evaluation allowance. If this were to occur respectively we would anticipate an effective income tax rate approximating statutory rates for about 38% to 39%.

In such case though we would still expect our cash payments for income taxes to be substantially less than our effective income tax rate as we would continue to utilize available NOLs.

Net income in the second quarter was $3.1 million, or $0.03 per diluted share. Excluding the impact of the previously discussed breakage benefit and asset impairment, net income for the quarter would remain $0.03 per diluted share. This compares to net income of $10.1 million or $0.10 per diluted share in the second quarter of 2008.

Excluding the effect of the prior year $1.9 million, non-cash interest charge net income for the second quarter of fiscal 2008 was $12 million or $0.12 per diluted share. We ended the quarter with a strong balance sheet.

At quarter end, we had cash and cash equivalents of $144 million. We generated $11 million of cash from operations in the second quarter and incurred $6.6 million in capital expenditures, which includes $6 million on new stores and remodel construction cost.

At August 1, 2009, inventory totaled $38.1 million representing a decrease of 14.6% as compared to August 2, 2008 levels. Average inventory per square foot decreased 14.9% as compared to the prior year second quarter.

Turning to our third quarter 2009 guidance, we estimate earnings per diluted share in the range of $0.02 to $0.05. This guidance is based on the following major assumptions. Total net sales between $138 million and $142 million, versus $146.6 million in the prior year third quarter. Comparable store sales between negative 6% and negative 9% versus a 7.6% consolidated decrease in the prior year third quarter.

Gross margin rose between 27.9% and 29.7%, of net sales versus 31.3% in the prior year, a decrease driven mainly by a deleveraging effect on occupancy costs from the forecasted comparable store sales decrease and a reduction in merchandise margin.

We also estimate current year SG&A expense between 26.0% and 26.4% of net sales versus 26.1% in the prior year quarter. Operating income in the third quarter is estimated to be between $2.1 million and $5.2 million, versus $7.1 million in the prior year third quarter. Operating income for the third quarter of 2008 included an asset impairment charge of approximately $500,000.

Interest expense in the current year quarter is estimated to be $135,000. Net interest income in the third quarter of 2008 was $378,000. We expect third quarter income tax expense of between $100,000 and $200,000. We estimate gross capital expenditures for all of 2009, of between $25 million and $26 million with offsetting improvement allowances of approximately $2 million for a net cash impact of $23 million to $24 million.

This includes approximately $18 million for cost associated with opening 17 new Wet Seal stores, as well as four remodeling approximately 32 existing stores upon lease renewals and/or store relocations.

We anticipate closing 16 stores when their leases expire, so we estimate nominal store count change if any in 2009. Our capital spending plan in those areas may change depending on the economic environment.

That concludes our prepared remarks. With that I will turn the call over to the operator to start a question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Lejuez - Credit Suisse.

Paul Lejuez - Credit Suisse

I’m just wondering if you could talk about how the off-mall Wet Seals are performing versus the mall locations, and also how you talking or how you are planning inventory for holiday right now especially Arden B? Thanks.

Ed Thomas

Sure on the first question related to the off-mall, we’ve had two off-mall test going; one of those stores in Fresno, California is getting its first anniversary and the results has been very good; the second one is on the Sacramento area that opened earlier this year. Those results have been very good. So our plans are to continue to compliment our regional mall strategy with an expansion into the Power Center locations and probably my guess is we’ll do it more regionally than just on a national basis.

Paul Lejuez – Credit Suisse

How about the inventory plan for holidays?

Ed Thomas

In terms of Arden B, as we mentioned earlier we played it pretty conservative with that division and now we are very confident in the sell-through, almost across every category where the demand has been exceptionally good.

So my expectation is that we are already planning more aggressive inventory levels and as we approach something like towards the end of the fourth quarter where we are going up against annualized reduced pricing and inventory, those inventories will start to hit last year levels on a dollar-per-dollar basis.

Steve Benrubi

Our expectations, at the end of the third quarter, its supposed to be down in dollars at 21% of Arden B. We expect the decline on a dollar basis to be much smaller and certainly the unit growth year-over-year which was 20% at the end of Q2; that will go up further at the end of Q3 going into the holidays.

Operator

Your next question comes from Liz Pierce - Roth Capital Partners.

Liz Pierce - Roth Capital Partners

Falling back on [inaudible] you said though the end of July you can see improvement. What about between July, and where you guys stand right now?

Ed Thomas

Liz, we’re releasing sales for August in a couple of weeks. So I’m not going to comment on current trends, but what I can tell you is; in the categories where we knew we had merchandise weaknesses, we made the most significant progress in our results in the fashion tops area and we like what we see there.

I think there’s still work in progress in two areas of the Wet Seal division. One is the dress category, we’re still under inventory and I’m not happy with where our assortment is yet, but I’m pretty confident that by early fall we’ll be back in position there.

The other category that’s been some level of weakness for us is in our Jewelry business and in Jewelry again is an area where because of the shift into other accessory categories like scarves during the second quarter.

First and second quarters, we were under inventory in that particular area and we’re in the process right now getting the inventory in Jewelry back in to shape. So the top area, which is most significant obviously in our business we’re seeing pretty good progress right now.

Liz Pierce - Roth Capital Partners

In Jewelry, I mean that’s fairly that you can easily get into those category, right, Jewelry?

Ed Thomas

Jewelry takes actually on average a little over a couple of months to get into it. I mean it’s largely manufactured overseas, we may source it domestically, but in terms of getting into what we want, it’s about a few month processes.

Liz Pierce - Roth Capital Partners

On the shoe business, it has been shoes and bags on part of the accessories?

Ed Thomas

Our shoe business, as you know we had a little built in the shoe business earlier on this year, because of a production issue, but since we’ve corrected that problem, our shoe business continues to be very strong and I’m expecting that to continue through the balance of the year. The real void, what we call the accessory category again is in the Jewelry area.

Liz Pierce - Roth Capital Partners

Then on the markdown optimization, so you said its one third and one third of source right now?

Ed Thomas

It’s one third of the departments, basically one third of our sales base is supplying it for all stores.

Liz Pierce - Roth Capital Partners

So you have already seen unless if you will, just mentioned in the markdown in the process?

Ed Thomas

I mean it’s kind of early to get a complete read out it. I mean we do see in some cases that in prompts some more accelerated markdowns than we might have applied in the past in order to move to merchandise, but in terms of getting all four read on and it’s a bit preliminary for us to start trying to quantify and share numbers on that.

Steve Benrubi

Yes, I think we’re going to have to get into a couple of more quarters with the full chain being onto the markdown optimization to really, truly quantify what the results are, but so far in the limited test that we’ve done it looks pretty decent.

Liz Pierce - Roth Capital Partners

I presume that’s all categories, all stores?

Ed Thomas

Yes.

Liz Pierce - Roth Capital Partners

Then you comment on 700, 750 give any sense what that would be for off-mall?

Ed Thomas

Our top priority is, we’ve talked a lot about the 100 stores that we’ve closed in regional malls that were closed in 2005, which were a top producers and those are definitely a priority for us. One of the test stores, we opened in the off-mall location was just 2.5 miles from the very high volume. Wet Seal store and we’ve seen no cannibalization of those sales at all.

So I think it’s too preliminary to predict how many will go in to each category. We know we still have, we’re in an unusual situation with 400 somewhat stores. The quality of real estate we can get into in regional malls is very unusual because of those store closings a few years ago. So obviously, that will be out top priority as we continue to build off-mall base.

Operator

Your next question comes from Eric Beder - Brean Murray.

Eric Beder - Brean Murray

Could you talk a little bit about the real estate? What are you seeing in terms of general real estate environment in terms of both new stores and in terms of redoing the lease, which you have in stores right now?

Ed Thomas

The availability certainly continues to go up. We can get into any mall that we want to get into today and it really as it has for a while now comes more down to the economics favorable or in the place that we think it needs to be for us to do deals. As soon as you saw, we had a target or an estimate of about 20 new stores this year. We did 17 because we felt, those were the ones that sold out right for us and we are getting those done.

On the remodel front same thing goes, we’ve got a lot of negotiation in the pipeline right now. We were hopeful I suppose that in the near term, certainly time might be more on our side in some situations, but the landlords are certainly not giving anything away and they are holding firm especially in the better quality malls and that’s been the case all along here.

Eric Beder - Brean Murray

In terms of the renovated Wet Seal stores, it’s going to be 18%, what do you’re seeing with them in these terms of difference in productivity? What should we think about in terms of the end gain, in terms of how and what percentage of the stores should be converted?

Ed Thomas

I think to answer the question on the productivity, during the fourth quarter where our results were better in the Wet Seal division, the results in those stores were better than what they were, that what they have trended out recently, but they’re still outperforming overall the balance of the chain.

So we’re pretty confident in that on a go forward basis when we have the balance of our merchandise assortment errors fixed at that the performance of those stores will be very good. In addition to that, most recently we’ve opened up probably about six other stores that were on a 100 store list and very good malls and the performance very recently, and the performance of those stores has in most cases exceeded what our expectations are.

So, we feel pretty confident that once we correct the balance of our merchandising mistakes, that we will get a nice acceleration of sales out of those stores. It’s really our mission, we have quite a few store leases coming up for renewal over the next couple of years and sticking to our economic model, wherever we feel that the economics are right, in some case, we’ll even accelerate renovating those store that make sense.

Eric Beder - Brean Murray

Finally, you’ve talked a lot about fixing the mix at Wet Seal. When should we start to kind of see that, when do you think it’s going to be where with the mix is going to be right where it should be for Wet Seal?

Ed Thomas

I think definitely during this quarter, we’ll see the mix and again I think the two, the top tier, I feel very good about progress we’re making there, which was a really a major mission of ours, because it’s such a significant portion of our business. We addressed assortment, I think we’ll see that.

We kind of know when we recognize the problems being in a transitionary period through the summer, we knew that we didn’t aggressively go after on a summer assortment because we were late, but certainly our plans are to be both of those both the jewelry business and the assortment addresses out for third quarter and I think likely Eric it will probably be sometime in September before we see both of those businesses be exactly where we wanted it to be.

Eric Beder - Brean Murray

How is denim doing? What kind of pricing trends you’re seeing in denim?

Ed Thomas

Well denim generally overall, has performed pretty well for us. I think what we’re seeing recently, especially in these initial back-to-school weeks, we’re seeing it be extremely promotional out there in the denim category. I think if you’re not on promotion, the demand is not going to be there as and we somewhat expected it to be pretty promotional category. Some of the new washes, that these stars that we introduced have done pretty well and basic denim continue to be very strong and some of the destroyed categories have been very good for us.

Operator

Your next question comes from Sam Panella - Raymond James.

Sam Panella - Raymond James

Looking at the Wet Seal division, the operating margin for the second quarter coming in around 6% obviously, down from the first quarter, I guess how should we think about that? Should we be able to correct that as we head into the third quarter, because typically the trend has been that operating margin comes down sequentially quarter-to-quarter at the Wet Seal division?

Ed Thomas

We feel we started the third quarter in August here in a better mixed position for the reasons that already described than we were in the second quarter and it was in all the way there August 1, it was much better.

So we do in spite of your valid point that historically there’s been some sequential fall off there. We believe the positioning of the inventory and the assortment was that much better on Wet Seal August 1 that we can improve on a sequential basis there.

Sam Panella - Raymond James

Then looking at our corporate operating income that came in better than our expectations, is that $6 million run rate and probably where if you have been doing anywhere from $7 million to $7.5 million in corporate operating income?

Ed Thomas

That was I mentioned in my prepared comments there was a $400,000 credit, it was related to corporate just incentive bonuses that are accrued over the course of the year and given our performance not achieving where we are targeted, there was a reversal in the second quarter.

So excluding that item that $6.1 million numbers more or like $6.5 million and that’s more representative number. Now we do have some seasonality with the beginning of our Sarbanes-Oxley work in some of our audit works. So some professional fees up tick a little bit in the third quarter, but that adjusted run rate I gave you for Q2, it doesn’t go a lot different from that.

Sam Panella - Raymond James

Lastly, with respect to Arden B now that you’ve the new pricing strategy and for I guess, since late last year. I guess what you are learning there in terms what categories are really resonating with the customers at those lower price levels? Or is it across the board just any differentiation there?

Ed Thomas

The very encouraging thing with Arden B is, almost of just of every category the sell throughs have been exceptionally good. So the demand has been there across the board, whether its accessories, fashion tops, or woven tops it’s been very, very good. During the last couple of months as Steve mentioned before, we unexpectedly if the sales accelerated during those two months and our plan that inventory very conservatively we could cult pretty quickly that our weeks on hand and inventory of almost in every category was too low.

The good thing is that, what we changed out sourcing several months ago due primarily domestic sourcing on and our ability to get goods is much better than what it has ever been in that division quickly and so we can bump those inventory levels a lot better than we could before and we feel pretty good about that.

Another comment related to that is, we can tell with the transactions being up as much as they are also our internet business in that division the demand is significant and so it is clear to watch that it’s primarily a shortage of inventory that is causing the cons to be a little lot.

Sam Panella - Raymond James

What are the lead times been at Arden B now with that domestic sourcing?

Ed Thomas

In some cases that can be as quick, four to eight weeks, it’s much quicker than it’s ever been. Our manufacturing days have been excellent in terms dealing with us, both in terms of maintaining quality and also helping us achieve our pricing strategy at decent gross margins.

Operator

Your next question comes from Elizabeth Montogomery - Longbow Research.

Elizabeth Montogomery - Longbow Research

I hope I didn’t miss it, but I’m wondering about your guidance for Q3 and given what you’ve said about feeling that you’re better positioned merchandize in the Wet Seal division had denser quarter.

What I would think will be just as diminishing and important as we go through Q3. I’m wondering, why you are not anticipating more of a pickup in the comp store sales rate? To your bases, it’s been roughly flat to Q2?

Ed Thomas

When we guide each quarter, we tend to look at where the environment is currently operating and we don’t anticipate just environmentally and it has obviously remained a challenging environment. So, that said, helps inform some of our thinking. We are anticipating obviously, with a down 6% to down 9% comp guide for the third quarter that is improvement over the second quarter top guidance.

That’s the by product of expecting some improvement in both the divisions from a gross margin standpoint around we do, within our guidance anticipates some progress there as well and certainly a narrowing in the gap between the prior year gross margin performance and the current year performance where Q3 tends to in recent years anyway have been a little more challenging on a gross margin line.

We are nonetheless guiding to an overall gross margin rate that is at or possibly better than the second quarter results. So, I think there are a number of factors that do point to our belief that we have made progress on Wet Seal and that there is opportunity that lies in the Arden B results with some more investment in the inventory.

Steve Benrubi

I just had one other things that is in the Wet Seal division, we have been dealing with a lot of shifts and tax free dates and I think really it is very difficult to read early results on what’s happening, but clearly where we have seen no shifts we have seen the impact of that.

I think from our perspective we would like to see, we will get a little bit more visibility because we know that back-to-school is going to be later this year in most cases and I think that combined with our ability to take the inventory will give us a little bit more visibility.

Elizabeth Montogomery - Longbow Research

Then is there anyway to get a sense for what dresses have historically been as a percentage of the merchandise assortment in the back half of the year and what the plan is for that this year?

Ed Thomas

Well we don’t really disclose percentages but the fall dress category in general has not appeared to slowdown at all and fall is a decent part of our business particularly Prom dresses starting with Prom dresses, our Proms and we are expecting that to the normal trends to change from what they have been and we have a pretty good indicator in the dress categories for Wet Seal from the Arden B division where dresses where we do have a decent dress inventory and that results in that categories have continued to be pretty strong.

Operator

Your next question comes from Jeff Van Sinderen - B. Riley & Company.

Jeff Van Sinderen - B. Riley & Company

I wonder if you guys can talk a little bit about how we should expect the full impact of your new merchants to down the fall in terms of timing and when can we actually say that now these two new merchants on the business?

Ed Thomas

Well I think these two new merchants is a significant upgrade to the experience level we had at that division. They know the market very, very well and they are already in a very short period time having immediate impact, the top tier where we can source our output.

Kim’s already had a major impact on very short period times, so I’m expecting that they will have impact for as we get into the September, October of timeframe both divisions will have a very positive impact on the business.

Jeff Van Sinderen - B. Riley & Company

Then I know you guys have talked about at some point automating your DC just wondering if that still on the calendar or where we stand with that?

Ed Thomas

It looks like we are definitely going to do it and plans right now call for either late beginning at the late fourth quarter in terms of establishing the foundation and doing it some time implementing it some time during the first half of next year and we can’t do it without any disruption to our business, the way it’s been designed.

Jeff Van Sinderen - B. Riley & Company

Then anything new in terms of your plans or initiatives for advertising and any color you can give us on current programs?

Ed Thomas

We continue most of our programs continue along the line of the grassroots. We still find e-com advertising to be a most effective channel and we continue to build that database of customers and that has been very effective for us. In the Wet Seal division, we have done a number of grassroots type of things with musical artists and we will continue to do that and in addition to the you will probably you will see as to a few more celebrity lines during the course of the year where there will be short term similar to what we did with Ashlee Simpson & Jordin Sparks.

Operator

Your final question comes from Anna Andreeva - JP Morgan

Anna Andreeva - JP Morgan

I was wondering if you can talk about what is embedded in your comp guidance by division. I think Ed you mentioned do you expect to see some improvement at both, but could we see comps improve to maybe down mid singles at the Wet Seal and Arden B top lines for volatile as you building inventories there or do you think you could begin to comp flatter at Arden B I guess over the next couple of months.

Ed Thomas

The only thing I could tell you is that Arden B probably has a bigger opportunity and I feel very confident in terms of us getting those inventory levels even today as we speak the inventory levels as we expect that in mid-August Wet Seal as we transition into fall. So, Arden B should have more of an impact, but Wet Seal does definitely have room for improvement over the previous quarter.

Anna Andreeva - JP Morgan

Could you comment about the transaction growth or its still in a 20s at Arden B that’s obviously great to see and you commented that you are seeing some new customers come into the brand. I guess any color where this customer is coming from, are you doing any thing differently in marketing wise to drive traffic to stores.

Ed Thomas

Well we definitely know that again with that been rewarded program we know that we have a pretty significant a prior customer base, so we definitely monitor on those and we believe that customers is still shop in pretty frequently in our store. In addition to that I think that what regaining our customer broadening our customer base and honestly I think we are picking up some market share from some of our competitors and do the combination of our great merchandise mix combine with our pricing strategy.

From our marketing standpoint what’s amazing about is that we really have done no external advertising however we haven’t even done any direct mail and we’ve anniversary a couple of direct mail pieces from last year and despite not doing that we still are getting a significant pop in transactions driven by pretty consistent message with our internet marketing.

Anna Andreeva - JP Morgan

I think you said just about every category at Arden B is performing very nicely and a couple of things to call out that are disappointing.

Ed Thomas

I really honestly there is nothing that I can think of that sticks our as terms of being avoid in that division right now.

Operator

Gentlemen, we have no further questions at this time. I’ll turn the call back over to you for additional or closing remarks.

Ed Thomas

Okay. Thank you, everyone for joining us today and this concludes our call.

Operator

Thank you for your participation.

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Source: The Wet Seal Inc. Q2 2009 Earnings Call Transcript
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