Charming Shoppes, Inc. Q2 2009 (Qtr End 8/1/09) Earnings Call Transcript

Charming Shoppes, Inc. (CHRS)

Q2 2009 Earnings Call

August 26, 2009 9:15 am ET

Executives

Gayle Coolick – Vice President, Investor Relations

James P. Fogarty - President, CEO

Eric Specter – Chief Financial Officer, Executive Vice President

Analysts

Christopher Kim - J.P. Morgan

Jeffery Stein - Soleil - Stein Research LLC

Scott Krasik - C. L. King & Associates, Inc.

Tom Filandro - SIG

Mark Cooper - Wells Capital

[Ildiko Hilber - Waterstone Capital

Presentation

Operator

Greetings and welcome to the Charming Shoppes second quarter 2009 earnings conference call. (Operator Instructions)

With us today are Jim Fogarty, President and CEO of Charming Shoppes, and Eric Specter, CFO and Executive Vice President.

I would now like to turn the call over to your host, Gayle Coolick, VP of Investor Relations for Charming Shoppes, Inc. Thank you, Ms. Coolick. You may begin.

Gayle Coolick

Thanks, [Latonia], and good morning.

Today's discussion will contain certain forward-looking statements concerning the company's operations, performance and financial condition, including sales, expenses, gross margin, capital expenditures, earnings per share, store openings and closings, and other matters. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those indicated. Information regarding risks and uncertainties are detailed in the company's filings with the Securities and Exchange Commission, including the company's annual report on Form 10-K for the fiscal year ended January 31, 2009 and the company's reports Form 8-K dated June 19, 2009. Our complete safe harbor statement and today's prepared remarks are available at www.Charming Shoppes.com.

Our second quarter income statement along with our balance sheet and cash flow statement are provided with today's press release.

With us today are Jim Fogarty, our President and CEO, and Eric Specter, CFO of Charming Shoppes.

Jim?

James P. Fogarty

Good morning. Thanks for joining us today.

In August we were pleased to announce the completion of two key initiatives - first, the signing of our credit card deal and completion of our revolver refinancing.

A few comments on the credit card deal. We announced that agreement to sell our credit card receivables program to Alliance Data and we entered into a 10-year operating agreement for the servicing of the program. We expect that transaction to close before the end of the year.

And the transaction itself affords us many benefits. First, it allows us further focus on our core business. Second, very importantly, it removes financing risk associated with our underlying credit card receivables securitization program and the credit risk of the credit card portfolio itself - a projected $110 million increase in our cash position and the attendant strengthening of our liquidity and financial flexibility. And finally we achieved these benefits in a projected non-dilutive transaction. We are partnering with one of the company's premier credit card providers and we believe we can continue to offer our customers superior service after we close the transaction.

The revolver refinancing. We also announced we have entered into a three-year loan agreement through July 2012 for a new senior secured revolving credit facility in the amount of $225 million.

Eric will provide more details on these two transactions following my comments, so now on to the quarter.

Our consolidated results for the quarter continue to reflect a difficult retail environment, delivering both disappointing comp store sales and earning power. Our sales reflected negative but generally improving comps to last quarter at our Lane Bryant and Catherines' brands, while our Fashion Bug brand had a difficult second quarter.

On the profitability front for the quarter versus last year, we were able to offset volume declines with disciplined inventory management, gross margin improvement, and reductions in both our occupancy and SG&A expenses.

A few comments on revenue. Our second quarter consolidated revenue declined $121 million or 19%. This 19% decline reflected 99 net store closings over the last 12 months and a comp store sales decline of 14%. Our sales reflected negative but generally improving comps to last year at LB and Catherines', as I discussed, and we made progress in those two brands on more balanced and compelling assortments. Fashion Bug had a difficult second quarter, with spring and summer assortments that were not compelling to our consumer; however, those assortments did not yet reflect our new product leadership.

Now a few comments on earning power. For the quarter our operating income before restructuring was $10 million, 2% of revenues. Our adjusted EBITDA for the quarter was $29.5 million or 5.6% of revenues compared to $32.7 million or 5% of revenues in the prior year. Our latest 12-month adjusted EBITDA was $20 million or 0.9% of LTM revenues.

GAAP to non-GAAP reconciliations are available on our website and whatever measure one utilizes, we are disappointed with the absolute levels of our earning power.

Now, results by brand: In Lane Bryant in the quarter they delivered $247 million of revenue and operating income of $12.3 million or 5% of revenues. Revenues declined 13% on a comp store basis compared to a 15% comp decline in the first quarter. Our Lane Bryant brand benefited from our value positioned outlet stores, which represented 14% of revenue in the quarter. Operating income was flat with a year ago as the operating margin improved 60 basis points versus last year's 4.4%, driven by improved quality of sales and a substantial increase in the gross margin, partially offset by negative leverage on our comp sales decreases.

Similar to last quarter, the Lane Bryant team had compelling product on the floor as reflected by the success of items featured in our monthly magalogs. We believe we underpeformed our potential for three primarily reasons. Number one, as I indicated last quarter, we did not have balanced assortments and would not correct our positioning until the back half. Number two, we are converting reasonably well with our existing customer base, but we are not converting as well with those we don't market to, i.e., our walk-in customers. And number three, we are not driving enough new customer traffic into our stores.

We are focused on initiatives to drive traffic and make our offering more compelling to those walk-in customers. As examples of some of these initiatives, we will be testing the utilization of our magalog in-store and will have product-led targeted promotions which seek to drive additional store traffic and compel conversion. We are working hard to take our Lane Bryant business foundation and better deliver in the back half of the year.

Now on to Fashion Bug. As previously discussed, the Fashion Bug business was in substantial transition this quarter. We were repositioning the brand, exiting juniors, girls and a number of missy sizes, remerchandising the floor to present plus and remaining misses sizes together in a lifestyle format, and moving away from extreme high-low pricing.

So in the second quarter, Fashion Bug delivered $189 million of revenue and operating income of $6.6 million or 3.5% of revenues. Revenues declined 18% on a comp stores basis compared to a 13% decline in the first quarter. Operating income decreased $13 million as our operating margin declined 440 basis points versus last year's 7.9%.

Our spring and summer assortments were not compelling and precipitated our comp sales decline, higher markdowns to clear those goods, and a deteriorating earning margin. This poorly performing product did not yet reflect new product leadership, which will not be fully reflected until our holiday 2009 assortments.

Based on our experience with our summer 2009 assortments and pricing, we are modifying and simplifying our pricing approach, maintaining some markup to drive product-led item-of-the-week style promotions. We are also winding down our Priced Just Right program to present the whole floor with a simplified pricing message. Our Fashion Bug team is hard at work executing our brand and product repositioning as we move through the back half of the year.

Now Catherines'. In the quarter Catherines' delivered $77 million of revenue and operating income of $6.1 million or 7.8% of revenues. Revenues declined 9% on a comp stores basis, in line with our first quarter performance. The business enjoyed the best comp sales of our three brands, coupled with strong improvement in its operating margin. Operating income increased $0.4 million as the operating margin improved 100 basis points versus last year's 6.8%.

Catherines' drove a relatively strong casual and career business and they improved the quality of their sales. We will remain focused on stabilizing revenue and delivering improved earnings at Catherines'.

Next, our private label credit card business. The earnings results of our credit business for the quarter exceeded our expectations as our total contribution from credit was $13 million in the quarter compared to $11.5 million in the prior year.

And finally Figis. With the termination of our M&A process, our Figis team is focused on ramping up for its most important and profitable period of the year, the fourth quarter.

Now, an update on our key initiatives. As we announced, we made a number of organizational changes during the quarter in support of our key initiatives. First, we appointed Tony Romano to provide new integrated leadership for global sourcing, distribution, logistics, quality control and quality assurance. Second, we appointed Bill Bass as permanent head of our direct Internet business. Third, we brought two brand Internet leaders onboard for our Catherines' and Fashion Bug brands. And fourth, we reorganized and brought on new brand finance leadership.

We talked about revenue focus last quarter. I'm not going to repeat what I said, but just recap. We talked about providing a compelling consumer product proposition first; second, stronger integrated marketing; and third, a focus on outfit selling. I'll now make a few more points on integrated marketing.

I know this company has discussed being multi-channel before and all I can tell you about that is we are now committed to adopting a multi-channel mind-set. We will encourage and make it easy for our customer to shop in three convenient ways - in-store, online and via telephone. We will also be multi-vehicle and coordinated in our communications with both existing and new customers, whether via direct mail, e-mail, online or in-store.

Our Internet revenue across our three brands for the first six months of fiscal 2009 was $41 million, reflecting a 5% increase from prior year. We are focused on increasing our Internet business across all of our brands. Our objective is to provide an improved online customer experience which will result in increased sales conversion and higher e-com penetration.

As a first step in that process, last week we launched brand new websites at LaneBryant.com, FashionBug.com, and Catherines.com, on time and on budget. The new online stores represent fresh and upgraded e-com platforms to support our core brands. The new e-commerce platform delivers many state of the art features, including improved navigation, better product presentation, personalized wish lists that can be retained, and an improved checkout process, all of which we hope will propel us in our quest to increase our Internet conversion and our e-commerce penetration.

Next, we talked about earnings power focus. On that focus, last quarter we said we would remain focused on savings initiatives and that cost of goods sold would be an opportunity. We believed we could improve our business model to deliver our customers' need for compelling value while better capitalizing on our total Charming scale, i.e., getting better prices for like-for-like product.

We are in the process of recruiting global sourcing executives for each of our brands. These leaders will be charged with improving our buying processes, adopting best practices, increasing our product gross margins, as well as helping on offense by partnering with our product teams to optimize critical vendor resources.

These and other changes we have made will upgrade and enhance our organization and support our key priorities, which remain, one, focus on the consumer; two, stabilize and begin to grow profitable revenue; three, increase EBITDA; four, increase cash flow; and five, employee empowerment with accountability.

With that, I'll turn it over to Eric.

Eric Specter

Thank you, Jim, and good morning, everyone.

We've made some changes to our financial presentation this morning with our earnings release that have mainly focused on our income statement. First, we are now reporting cost of goods sold, occupancy and buying, and depreciation and amortization separately on the income statement. Second, our fiscal year designations will now be aligned with the calendar years.

The first change is intended to improve our transparency and disclosure of information and make our conversations with you more productive. The second change is to align our internal and external thinking on fiscal periods. Our results for the current fiscal year ending January 30, 2010 are reported now as fiscal year 2009. When we refer to our fiscal year 2008, this will mean our fiscal year ended last year, January 31, 2009, and so forth.

Now to the quarter. Net sales for the quarter were $527.2 million and decreased $121.4 million versus a year ago. The main driver of the 19% decrease was our comparable store sales decline of 14% as well as 99 net store closings over the last four quarters.

We provided detail in the press release on sales by brand. Our results included an 18% decrease in inventory on a same-store basis. By brand, comp sales declined by 13% at Lane Bryant and inventory declined 13% on a same store basis. At Catherines', comp sales declined by 9% and inventories were down 14%. At Fashion Bug comp sales declined 18% while inventories on a same store basis were down 27%.

Also at our Fashion Bug brand, we have exited the junior and girls businesses and the smaller misses sizes as of the end of the previous fiscal year, creating for the short term additional pressure on the top line at Fashion Bug as we remerchandise the space to present a lifestyle approach throughout the store for plus and for larger misses sizes.

Gross profit was $263.9 million in the quarter, a decrease of $39 million, mostly related to lower sales volume. Gross margin improved by 330 basis points to 50% of sales compared to 46.7% of sales for the year ago period. This increase was driven by an improved merchandise margin related to lean inventories and reduced markdowns at our Lane Bryant and Catherines' brands.

Occupancy and buying expense decreased $5.5 million or 5.2% related to the operation of fewer stores and occupancy reductions secured, somewhat offset by increases in buying costs. Occupancy and buying expense as a percentage of sales increased by 270 basis points as a result of negative leverage from the decrease in consolidated net sales.

Selling, general and administrative expense decreased $30.2 million or 18.4% to $134.3 million in the second quarter compared to $164.5 million in the same quarter last year, primarily related to expense reduction initiatives and the closing of underperforming stores. SG&A expense as a percentage of sales was 25.5% and essentially flat year-over-year.

We recorded restructuring charges of $7.8 million in the quarter primarily for accelerated depreciation on discontinued on divested catalog businesses and costs related to our transformational initiatives. $3.3 million of these charges were non-cash.

Income from operations excluding those restructuring charges was $10.3 million, an increase of 5.7% compared to $9.8 million in the year ago period. We achieved this improvement on a 19% sales decline.

Jim's comments included detail on profitability by brand. In summary, we experienced year-over-year improvement at our Lane Bryant and Catherines' brands, while our results at Fashion Bug were below last year's performance. These performance metrics will be more fully detailed in our 10-Q, which we expect to file late next week with the SEC.

We have increased the number of planned store closings this year by approximately 45 stores to reflect our ongoing evaluation of our store portfolio. The additional store closings primarily represent Fashion Bug stores that have lease expirations scheduled for the end of the current fiscal year.

Last quarter we spent time reviewing our adoption of APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled In Cash Upon Conversion, which changed the accounting treatment for our 1-1/8% senior convertible notes due in 2014. APB 14-1 has also been retrospectively applied to our company financial statements for all periods presented. Please refer to our 8-K filed on June 19, 2009, which provides disclosures on retrospective restatements we have made related to the adoption of APB 14-1 and our accounting treatment of the debt amortization.

This quarter we recorded $2.6 million as a non-cash interest expense for accretion of the discount and the debt was increased correspondingly by $2.6 million. Adoption of APB 14-1 does not affect our cash flows and does not change our fully diluted share count for the purposes of EPS calculations. Non-cash interest expense related to the adoption of APB 14-1 represented $0.02 per diluted share in both three-month periods presented.

We continue to have a valuation allowance recorded against our deferred tax assets. The tax provision for the second quarter primarily represents certain state and foreign income taxes as well as required deferred taxes.

On to the balance sheet. Our balance sheet continued to remain strong and our total liquidity was $316 million at the end of the quarter. Our liquidity includes $117 million in cash and net availability of $199 million on our fully committed and undrawn line of credit. Our strong liquidity allowed us to opportunistically repurchase $38.2 million of our convertible notes for a cash price of $21 million or 55% of par. We recognized a gain on this repurchase of $7.3 million, which is reflected in our income statement as a separate line item. Year-to-date, our cumulative repurchases were $51.7 million of face amount of notes at a cost of $26.6 million or 51% of par.

Although our notes are discounted on the face of our balance sheet in the amount of $168.8 million, the economic reality is as of today we continue to have a liability of $223.3 million in notes, which was the original $275 million issuance less the $51.7 million face value we have repurchased from the beginning of the year through the end of the second quarter.

With regard to our credit securitization program, we ended the quarter with $495 million of credit card receivables compared to $585 million in the same period the prior year, a decrease of $90 million. As a result of decreased expenses for the program this quarter, the total contribution from our credit program increased to $13 million for the quarter compared to $11.5 million last year.

I'd now like to provide additional detail on our agreement with Alliance Data and how the execution of this agreement will impact our financial statements.

This transaction results in the monetization of our investment in asset-backed securities which have been recorded as a current asset on our consolidated balance sheet. Today's balance sheet reports approximately $100 million in our investment in asset-backed securities, which we project will grow to approximately $110 million at the end of the third quarter ending October 31, 2009. Upon closing of this transaction we expect to record an increase in our overall cash position by approximately $110 million.

Alliance Data will assume the servicing obligations of the credit card receivable program. Furthermore, we will have no further financing obligations with respect to our credit card program.

Based on credit sales generated by the retail brands' private label credit card program on a go forward basis, we will receive annual payments from Alliance Data. These payments are expected to substantially replace our net credit contribution related to our credit card business on a trailing 12-month basis and will be recorded as a reduction to our SG&A expense. As we announced, this transaction is projected to be non-dilutive based on the trailing 12 months net credit contribution as of the second quarter.

Finally, I would like to review our new senior secured revolving credit facility of $225 million. This is a three-year loan agreement and replaces our $375 million facility, which was due to mature next year. We are pleased to have proactively and successfully addressed the maturity of our previous revolving credit facility. The new facility provides committed revolving credit funding through July, 2012.

Over the last year, we have actively sought to simplify our business through the divestiture of non-core misses apparel catalogs and the closure of Figure Magazine, ShoeTrader.com, and the Lane Bryant Woman catalog. Given these activities, we have reduced the size of our new revolving credit facility to one that is appropriate to our current business model.

Borrowings on the facility will generally accrue interest at a margin ranging from 3.75% to 4.25% over LIBOR. At this time there are no outstanding borrowings on the revolver. As long as the excess availability under the new facility is at least $40 million, there are no financial covenants applicable under this facility.

At this point we'll open the call up for questions. Thank you.

Gayle Coolick

Latonia, we're ready for questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Christopher Kim - J.P. Morgan.

Christopher Kim - J.P. Morgan

You guys talked about being moderately more aggressive in terms of the marketing spend for the back half of the year. Is that exclusive to the Lane Bryant business and how will that affect overall SG&A?

James P. Fogarty

I don't think we said we would be aggressive on what we would spend. I think we talked about how we would have a mind-set of approaching marketing and being integrated to drive customers via either Internet or in the store or online.

We did say in Lane Bryant that we would look at some initiatives to use our marketing books, our magalogs, to try to drive traffic when it gets to the store, sort of walk-in traffic, to make sure we could utilize that marketing vehicle.

But there's sort of combined answer, wherein we're also being very aggressive on how we manage our direct marketing spend to make sure that we're getting appropriate incremental sales and ROI at the end of the day on how we execute our marketing spend.

So I don't think I would read into that that somehow we're going to, when the dust settles, at least as we think about the back half of this year, that we're going to somehow see some increase in overall marketing spend.

Christopher Kim - J.P. Morgan

And also regarding this sort of platform that you're starting to build in terms of being able to be better at direct sourcing, perhaps also enhancing your in-house design efforts, can you kind of give us a timeframe around that and when you'd be better able to capitalize on that structure?

James P. Fogarty

Sure. Maybe I'll break it into two pieces. On the design front, the design talent is - let's just focus on Lane Bryant and Fashion Bug - the design talent is in place and has been in place. As you know, in retail apparel there's sort of a lead time before the work one does actually ends up in a store. So based on when those folks came onboard at Lane Bryant and Fashion Bug, what we've called out is the new product leadership through our design organizations underneath our brand presidents will really start affecting the product on the floor in a more complete way in this holiday of 2009, so the holiday period this year. So design is sort of in place.

On the sourcing question and building a better sourcing platform, we have a key piece of it in place now, which is the executive leadership in Tony Romano and so we're starting to make progress now. But the other important thing that Tony is doing and is spending a lot of his time on is recruiting leaders to work with our brand presidents and their teams within each of our brands. And that recruiting process is happening as we speak, and we would frankly hope to report landing those folks next time we talk, they would be on board with us by the next time we talk, and that would be one for each of our brands.

Christopher Kim - J.P. Morgan

And just for Eric, on the gross margin in the quarter, of the 330 basis points can you kind of give a little more granularity in terms of was it a function of better buying or better selling - so IMU versus markdown?

Eric Specter

The IMU was fairly consistent given on a consolidated basis, but let me first comment on the fact that the Lane Bryant brand and the Catherines' brand were up well over 400 basis points. Fashion Bug, as Jim commented in his remarks, was slightly below last year. Most of that margin improvement, the 330 basis points, come from the fact that we did not need to be as promotional; we did not need to take as aggressive markdowns. The business model we're moving forward on is to retain more of that initial markup.

So we're not really at this point seeing the benefits of the cost reductions in the cost of goods sold. It's mainly driven by the performance of the product, as well as the fact that we are exiting prior seasons much earlier and we're not taking anywhere near the size or magnitude of clearance markdowns as we move through the season. That will also be true as we've now exited summer season and started fall. Our summer inventory, carryover inventory, was significantly lower going into fall than the prior year to the tune across all three brands of approximately 40%.

Operator

Your next question comes from Jeffery Stein - Soleil - Stein Research LLC.

Jeffery Stein - Soleil - Stein Research LLC

A couple of questions, first for Eric. I'm wondering if you can address, Eric, the performance versus plan for the quarter since you don't provide guidance? And also, just housekeeping, are you going to provide any restated quarterly data so that we can model Q3 and 4 on a basis consistent with your new reporting?

Eric Specter

Okay, so I'll take care of the latter one. Certainly, we will be providing that information. It certainly will be completed by the time we file our Q next week. So over the next three or four days the information - of course, we reported today the first and second quarter both consistent with reclassing last year's buying and occupancy and depreciation and amortization. We will provide that in the next few days, early next week, relative to the third and fourth quarter for everyone's modeling purposes.

As it relates to the first question, Jeff, we're obviously in a situation where the plans, we're constantly tweaking them. Directionally, I think how you could take the quarter as we released it, we certainly were disappointed in our Fashion Bug results, both on the top line and the earnings, whether you look at earnings as an EBIT or EBITDA number. We were pleased with the margin improvement both at the gross margin and operating margin levels at our Lane Bryant and Catherines' brands.

So to get into any other ratios, clearly we achieved our expense reduction initiatives as you see across now the buying and occupancy as well as SG&A, a little over $39 million for the quarter. So all brands, as well as our corporate and shared service initiatives all delivered. And certainly if you look at where we are through six months against our year end announcement of $125 million of cost takeout for the year, we're well under way in achieving those goals and initiatives.

Jeffery Stein - Soleil - Stein Research LLC

Eric, what happens to cost of goods sold in the back half of the year? I take it that most of that benefit is still ahead of you?

Eric Specter

Correct. And what you're speaking to more is the margin. Again, you're speaking to last year's third and fourth quarter, obviously, with the entire financial meltdown in the second half of the year, which really started mid-September on. Clearly, you're speaking to the fact that we had depressed gross margins with, obviously, the cost of goods sold increasing in each of those third and fourth quarters. That's correct.

Jeffery Stein - Soleil - Stein Research LLC

What I'm speaking of is lower sourcing costs out of the Far East just due to excess capacity and so forth. Just generally, what kind of declines are you seeing in product acquisition costs year-on-year?

James P. Fogarty

Maybe I'll answer it in terms of - like other businesses, there's a bit of a lead time to get at some of that. So I would tell you our team is kind of finishing up processes around spring of next year, spring of 2010. Then we'll have summer and we'll have etc., etc. And so as they work on that, we don't have all of the sourcing talent in place, so I'd say we're trying to affect spring and we will affect more of summer and more of fall and holiday thereafter.

In terms of driving discipline around getting savings like-for-like, not dissimilar to how we're managing our landlord base, we're trying to get savings from our partners, our vendor partners, and make sure everybody along our whole supply chain or value chain is sharing in these unfortunate reductions in consumer demand.

Jeffery Stein - Soleil - Stein Research LLC

Jim, one final question for you. You guys have done a terrific job so far getting the cost structure down. To me it seems at this point that it's all about sales and I'm just wondering what we should be looking for as outsiders in terms of an inflection point for each of the brands and is there anything new and different for back-to-school at each of the brands that potentially could serve as that sales catalyst?

James P. Fogarty

I think it'll all start with - we won't bore our conversation around the external market environment and all of that. It'll start with that.

But in a context of that being normal, I think folks normal expectation - well, expectations, I guess, are all over the place, but if you assume that there's some stabilization occurring in consumer demand as we move into next year, we would of course hope to enjoy that, too.

And in terms of how we're playing back up all I'd tell you is when Eric and I look back with the brand leaders at the history, we've been a very casual clothing-oriented organization. We've not done as well in the back half of the year if you look at how we do in the back half versus department stores and, frankly, other specialty women's players.

So we're trying to be as focused as we can in affecting the back half as best - I don't think we're ready to get into a particular quarter the particular specifics, but we have, for instance, our Lane Bryant team focused on what product it's going to lean into in that season, and then Lane Bryant, Catherines' and Fashion Bug trying to become more giftable, trying to drive gift cards, trying to drive an appropriate window marketing approach, in-store approach, to really play into the holiday season appropriately. So those are the kinds of things we're doing.

And we talked about trying to test and drive conversion in Lane Bryant. Because we've done such a nice job with our existing customer base, you know, as a call to action getting them to come into the store and buy the product that we show them in our books, we think we've struggled with the walk-in customer who doesn't have that part of the experience. So we are trying to figure out a way to use those books, version those books so that we can use them in-store not dissimilar to how you might see a J. Crew use its books in-store and those kinds of things.

So we're not going to lay out all the specifics of what we're trying to do, but we're just trying to - some of this takes some time. So will we have an optimal answer for the back half of this year? No. But we're working on both the product end and the marketing end to make sure we can optimize as best we can and then keep working on our planning as we go into next year, to be really thoughtful. You know, a lot of this business is in the execution, as you well know, and be thoughtful of when we're converting from one season to the next.

One of the good pieces of news as we're coming out of the second quarter is the teams have done a nice job being disciplined about taking the markdowns and moving the product as they move into the next season. So our inventories are down, yes, but they're also, in terms of - you saw a comment from us in terms of the carryover inventory from second quarter moving into the back half. We're in a far, far better position this year versus last year.

Operator

Your next question comes from Scott Krasik - C. L. King & Associates, Inc.

Scott Krasik - C. L. King & Associates, Inc.

Eric, can you break down the comp a little bit, at least for Lane Bryant? What were the transactions versus AUR, etc.?

Eric Specter

Again, it's a very similar pattern to the first quarter. We're enjoying much higher average unit retails, AURs out the door. We are enjoying much higher ADSs out the door.

In terms of the average dollar sale, clearly it is a traffic issue that's in effect driving the negative comp. The traffic continues to be down double digits in the second quarter through the store, but we are seeing a very good response, particularly to the mailed customers. We mail anywhere from 3 to 3.5 million of our Lane Bryant customers each month. We've talked about Brian Woolf, the president of Lane Bryant; we use a magalog that could be anywhere from 20 to 30 pages. That's been embellished in these subsequent months and there's been some enhancements made for fall.

So we continue to see a very good response from the core customer, both their average unit retail, their average dollar sale being up against last year and, of course, at much higher margins.

So the negative metric in your question, Scott, clearly continues to be the traffic patterns.

Scott Krasik - C. L. King & Associates, Inc.

And just in terms of the balance of AUR going up versus traffic going down, is the improvement quarter-over-quarter due to traffic not declining more or is traffic still declining?

Eric Specter

No. Again, it's still - what it is is it's a continued improvement. As I mentioned, Lane Bryant had a little over a 400 basis point improvement in gross margin. Again, the mix of product on the floor and the inventory strategy of not carrying anywhere near the units or dollars of spring/summer inventory. So when I made the comment that overall we're down 40% in carryover inventory at the end of July, I think you can conclude that in order to achieve that you've got to be carrying a lot less summer product through June and July in order to get those kinds of end-of-quarter numbers.

So what we're trying to do is we're effectively trading off lower margining, although we would sell more units, discounted marked down summer product for converting earlier and bringing in transitional fall and June and July; it's more wear now. Then, of course, as we get into the latter part of August and get positioned for September, we are now positioned in a much better mix of our fall product versus the summer clearance.

So, again, the improvement was really driven by the higher average unit retail and higher average dollar sale that we got out of the customer on what I would call very, very similar type conversion rates that we saw in the first quarter.

James P. Fogarty

And let me jump in there. Somebody brought up what I think was a good point, that as you see us get down, now, to our core business with liquidity stabilized - actually strong; it's more than stabilized, it's strong - and our revolver in place and we've gotten the credit deal done and we've gotten all those basic cost savings initiatives in place - there's more to be had; there's more COGS  we do start to move to a place where, somebody used the phrase, we really need to start optimizing our revenue. And now we need to have profitable revenues. We're not going to just chase market share to chase market share. We want to have profitable revenue driven through the business.

And so in doing that, when you look at Lane Bryant - and to some extent all of our businesses, but just to focus on the Lane Bryant question - we do need to figure out how to drive new traffic. There are plus size women out there who are - some of it is they're taking some of their dollars to other competitors and we want those dollars back home. But other parts of it there are customers who don't shop us at all - how do we get at them? And the team is - some of that is through window marketing, some of that is do we have an acquisition strategy?

So we're doing some research. We're not going to just shoot from the hip. We're doing some research to understand the customer base, and I think we'll be back to you as we think through whether, beyond just the window showing your stuff, is there a way to get at, let's say, customers at some key department stores that Lane Bryant competes with. So we're very focused on that.

And then in terms of, just to give you some - I didn't want to get into sort of the product coming in the future, but maybe I could talk about the product positioning that you would see in our stores now. I think in Lane Bryant and our other brands, like much of the retail space right now, we've pushed forward a very casual, denim-oriented positioning. You'll see lots of folks out there with a heavy denim positioning.

So our teams have the same jeans you've sort of heard, the missy cut. Any of you that follow the missy businesses, you've heard the boyfriend jean, the skinny jean. We are positioning and driving that both to do that volume, to do the tops that go with that bottom volume, but also as a way to - it creates excitement in the store and gets them to shop the store. So our teams are focused on that, whether it be Fashion Bug, Lane Bryant or Catherines'.

And then as another example, in the intimates business - pun intended, I guess, which is a foundation business for the overall retail store, the Coke and Pepsi, if you will, that keeps the customer coming back - the team at Cacique, which is our very strong intimates brand within Lane Bryant, has brought out a new bra called the back smoother bra, which they position very nicely online, little video clips online trying to position the pieces, and also in-store marketing. And we're seeing some nice success there.

And I think all of our brands are attuned to - Cacique has done the best job of the three brands, but our other two brands are also attuned to figuring out how to have a much more successful intimates base to their business because it's so important to keeping the retention of the customer and the traffic flow.

Scott Krasik - C. L. King & Associates, Inc.

Cacique, in general, for the quarter, was that comp - was your intimate comp similar to the store comp?

Eric Specter

Actually, much better.

Scott Krasik - C. L. King & Associates, Inc.

You tested some higher price point branded, quasi-branded stuff at Lane Bryant through the bubble. Is the approach in 2010 or holiday in 2009 and then into 2010 to focus more on value or do you still believe in offering some of the premium denim price points, etc., going forward?

James P. Fogarty

We want all of them. Basically what you'll see actually - we have a magalog that'll be sort of hitting next week, I think it is, and we've positioned, for instance, to try to have - don't get worried on the costs - but we've positioned a small collection, icon collection, to try to sort of up the brand equity, a little bit of an umbrella that Brian Woolf and the team have worked on that'll be in about 100 doors in-store next week, which is actually taking the price point up, a much better product. It's another choice.

You'll see guys like Nordstrom and Neimans and others are getting into the plus space, interestingly. As their designers have struggled with, you know, the luxury market's very tough, so they're actually getting into that space a little bit.

That's not why we're doing it. We're positioning because we think there's a big piece of our customer base that doesn't shy away from the price point and really wants, you know, it's like a woman anywhere in America, wants really nice stuff.

But then there's also a piece of the customer base that wants value and there are pieces of the customer base that we don't have, some of which want a little bit of a premium edge and some of them want value. So we're trying to thread the needle and do both, that kind of premium umbrella piece in 100 doors, good solid pricing and margin structure across all our stores, but then also to be targeted promotionally so that the windows can draw the customers in and so we can have a promotional point of view. It's a careful balance, but we're kind of trying to do all of the above.

Scott Krasik - C. L. King & Associates, Inc.

And then just lastly, the EBIT numbers that you gave by division, do those exclude any corporate expenses or have you included?

Eric Specter

They exclude, Scott, our corporate overhead and shared service back office expenses that are primarily within finance, HR-type functions.

James P. Fogarty

Which will be broken out in the Q, right? The operating income numbers we talked about today will be in a table in the Q, with a corporate expense line.

Eric Specter

Well, in the 10-Q - and this would be no change - we do segment our retail brands in aggregate under a retail segment and then, of course, there's a corporate segment in the Q that would get to some of the numbers, Scott, you're looking for.

Scott Krasik - C. L. King & Associates, Inc.

Can I take those and add that, the corporate that shows up in the Q, because you don't break it out by banner in the Q.

Eric Specter

Well, that's true, but we're accounting for it in aggregate and ultimately not -

James P. Fogarty

So it's like Eric, we'd have to chop up his body to allocate it.

Eric Specter

Exactly.

James P. Fogarty

So whatever expenses really belong to the brand very directly were given to them. So there'll be some movement of that stuff over time, but then just kind of general IT - if it's POS it goes to the division; if it's like general stuff it sits in sort of a corporate pot. It's the way Eric and I are thinking it through.

Scott Krasik - C. L. King & Associates, Inc.

Any thoughts of formalizing those disclosures towards individual banner segments as opposed to consolidated?

James P. Fogarty

Maybe I'm not being clear. So expenses that are part of the division will sit in the division's earning power. Expenses that are more general - if what you're saying, will we come up with some allocation and show it in some allocated way? No.

Scott Krasik - C. L. King & Associates, Inc.

No, no, Jim. In the Q as of right now your segment reporting only shows the retail stores consolidated and direct-to-consumer. Would you think about having Lane Bryant -

James P. Fogarty

I'm sorry. The retail then is - what Eric was saying, the retail is then broken out by brand. It is broken out by brand in the 10-Q. If you look at the first quarter Q, there's a table in there if I remember correctly that is like, I'll call it - I'm not going to use the GAAP term and I might have to do a reconciliation after I say it - but it's EBIT in one column and D&A in another column by brand. And somebody just - is this the first quarter? Page 35 in the first quarter.

Scott Krasik - C. L. King & Associates, Inc.

Oh, yes. I'm sorry. I was not that far down. Okay, forget the whole conversation.

Operator

Your next question comes from Tom Filandro - SIG.

Tom Filandro - SIG

Regarding the new e-commerce platforms across the brand, can you provide maybe a better understanding as to what features you believe you now have that will help generate increased business there and can you better help us understand e-commerce penetration by brand and maybe give us a sense of your goals near and longer term?

James P. Fogarty

So Bill Bass, just the guy that's doing this for us, gets the Internet space - at Land's End he sort of built that Land's End Internet business - as well as gets the catalog space. So we've got the right guy helping us think about this.

But on terms of penetration - so his basic point is we think we should have better penetration in total than we have today. So he would look at $41 million for the first half; he would just say that's too low. The penetration, that $41 million, your total apparel, the three brand revenues, is too low. And he would say it's got to be higher.

Now in terms of mix, internally Lane Bryant has the best penetration of the three, even Lane Bryant's is too low. And then Fashion Bug and Catherines' are very small businesses and we hope to grow them. Catherines' has a little better penetration than Fashion Bug. So there's opportunity at all three. Lane Bryant is the most penetrated of the three, but across the board it's a big opportunity if we do it right.

In terms of what changed, I called out a few of the things. Improved navigation, that's a hard one to describe. In the old Internet platform - you have to sort of go out and shop the sites, but in the old platform it was more cumbersome to move through the sites. It took a lot more clicks, so to speak, to get to buy something. And so you can't make it hard. These people want to buy; you can't make it hard for them. So Bill's very practical about it - I want to make it easy; I want to reduce the amount of clicks it takes to go buy something. And he's worked on that.

And we've worked with Fry. Fry is the company Bill chose to do this work, to work with, and Fry gets this space and really provided a nice technical platform. It's an open architecture platform which allows us to be flexible in how we use that platform over time.

So, anyway, navigation, better product presentation. There were just things that the old sites didn't allow us to do in how we put product out there; trying to do things like wish lists, where the wish list is retained by the site.

And then improving the checkout process. Here we are, they come to the checkout, and we make it hard for them to send in their credit card payment.

So it's a lot of stuff. I can't put a number next to each piece - and Bill would also caution, we've got the new platform; some of the people got really used to using the old platform, there'll be a little bit of an adjustment period - but when we come through this, the other thing we're having all of our brand teams spend more time, frankly, going on the sites and thinking about the Internet business and how we can better drive it.

And Bill likes to tell the story that one of the things that we came to understand is the way our incentive structure was designed we were driving our store managers and store people around incentives only to do business in the store. So to the extent somebody who shops in the store regularly did some business on the Internet, it wouldn't count for the incentive. So think about the logical implications of that, you know? I'm a store manager. Why the heck am I going to try to get on the bus and try to drive Internet if it doesn't count in my bonus. So we're going to fix those kinds of things.

It's a lot of stuff, execution stuff, that we think if we do it we can have a nice business. And the other thing to point out is our consumer skews to Internet. In other words, our consumer likes to shop from home. There's lots of businesses, even when we think about our Catherines' business, we sort of have plus sizes throughout all of our businesses and then Catherines' handles even larger sizes than sort of the larger plus range, and those folks, as we study those folks, they skew towards liking to shop online. So it just seems like a natural for us. We just have to do a much better job executing online.

Eric Specter

And, Tom, the other additive, just to talk a little bit about, with Bill Bass at the helm of executing our multi-channel strategy, in our magalogs at Lane Bryant, we started this a few months ago but it's now more pronounced in terms of three ways to shop, they also can use a 1-800 number and order the product right off of that 28-page or 24-page magalog. That was not available earlier in the year or in the prior years.

We've maintained a very small presence in Tucson, the remnants of our sale of Crosstown Traders, where we've got a very small group of individuals running a call center, and they're handling both the e-commerce customer service as well as the calling, the phone orders.

So this is just an example of how we're going to continue to look to increase market share across the three channels in a very integrated way that we were not doing effectively the last couple of years.

James P. Fogarty

Now something that people will always sort of follow up and ask about, just to hit it, is that, well, won't that cannibalize your in-store business? And the answer is probably yes to a degree, but when people have studied being multi-channel, when you're multi-channel with a customer, those multi-channel customers are most engaged with the company and they directionally tend to do 2.5 - 3 times more revenue with a multi-channel customer versus somebody who solely shops either in-store or Internet.

So if we can get people to do both, it just gives them more touch points with the brand. And think about it, if we can have more of those touch points versus the department stores - you know, they cross shop; they spend some of their money with us, they spend some of their money at department stores - so if we can be smarter about all of that, that should help us.

Tom Filandro - SIG

One follow up, Jim. You talked about the initiatives to drive new file shoppers as well as converting I think you called them walk-through shoppers. You mentioned the magalog. Can you give us a sense of will all stores have the magalogs, what magnitude and the numbers, and the timing of that as well? And is it fair to assume if you're getting more aggressive in that regard that you feel a lot better about LB's balance of inventory, which you alluded to in spring, would take time to fix? Will we be there for the fall season?

James P. Fogarty

I think the team is feeling good about the product it's going to have on the floor, that, frankly, that it has on the floor as we go into next week and into holiday in Lane Bryant.

And in terms of the books, we've done some testing of the books in stores as bag stuffers with a bounce-back coupon, and that seems to have worked and we're now going to test it in-store as a method of just helping the consumer shop the store. And maybe that's a smaller book so it's not as expensive, but it has some of the key outfits shown. We're trying to position it so we could use that kind of an approach through all stores. So we'll do some bounce-backs with the normal book, as bag stuffers, that has worked for us, and then we'll also assess using those smaller version books in all stores as sort of helpers to the shopping experience and see how that goes.

So I think that's common. I think we may do some of that in a bigger way here as we move into holiday. I don't think we've called the final shot, but that's what we're thinking about.

Operator

Your next question comes from Mark Cooper - Wells Capital.

Mark Cooper - Wells Capital

I just had a question about the inventory levels. Certainly the number suggests you've wrung out quite a bit of cash out of that. Is that consistent across the brands? Are you done with inventory type of liquidation or do you think you still have some room to go? What do you think there?

Eric Specter

I wouldn't characterize it, Mark, as inventory liquidation. This was a planned strategy from inventory management that goes back to the end of the fiscal year where we felt that our mix and our entry and exit of seasonal inventory could be dramatically enhanced.

Mark Cooper - Wells Capital

Well, that's a bad choice of words on my part, but you've turned a lot of it into cash and that's helped the cash flow in the last year.

Eric Specter

Yes, I think that's a fair comment. Clearly, we have reduced our inventories and certainly when you look at our free cash flow and the working capital in the business, clearly inventory management has been a source of cash to help us through it.

We made this comment earlier in the first quarter, that we would see continued double-digit drops in inventories year-over-year through the second quarter. It'll start to slow down in the third and fourth quarters because again, to your comment last year we were starting already to reduce as early as the third quarter and then of course the year end numbers into the fourth quarter were in line in terms of being down double digit.

We still are constantly managing that. We still believe we can turn the inventories faster so there will be still improvement year-over-year, just not to the magnitude that we've seen here in the first couple quarters.

James P. Fogarty

And I would just add, somebody mentioned as we've gotten down to this core it's time to think about optimizing revenue and stabilizing revenue. Optimizing revenue for us now means getting to stable over time here, and in doing that I think the merchants and the brand presidents will continue to work it and try to work it where we're not getting the right [inaudible] on certain pieces of the inventory, try to figure out a way to improve that, either improve the margin of it or turn it faster, all those kinds of things.

But I think you'll start to move into a place of not having large incremental opportunities to reduce the size of the inventory. It becomes more about trading out of one style and reinvesting the dollars in other styles and other product categories. And then more about we need to, look, when people manage [inaudible], for us, as long as it's not cannibalizing other businesses, as long as it has a reasonably positive [inaudible], it brings more money to the house.

So the way we're thinking about it, there may be some things where we want to grow into a new piece of business within our existing stores, in other words, new product categories. We're getting ahead of ourselves a little bit, but we've got to think about driving the business and you can't drive the business if you don't have the inventory there.

Mark Cooper - Wells Capital

You've got to have something to sell. I'm just trying to get a magnitude of how much extra cash is coming out of working capital.

James P. Fogarty

I think it's directionally coming to an inflection point on whether we have inventory, positive inventory - what I'd prefer to do is to have a business that's growing and tell you we increased inventory.

Mark Cooper - Wells Capital

And then, Eric, you said in the Q you're going to provide the November and January comparable quarters from last year under the new format. Is that correct?

Eric Specter

Well, no. Just to clarify that, as I mentioned, we're planning to file the second quarter Q. It would not be in the Q, but Gayle will have those numbers available to distribute.

Operator

Your next question comes from [Ildiko Hilber - Waterstone Capital].

Ildiko Hilber - Waterstone Capital

You talked about incremental store closures and I'm not sure how much was left from old plans. Can you give us a sense of how many stores you expect to have at the end of the year, if you can, by format?

Eric Specter

In aggregate and then I'll turn it over to Gayle, but I believe we closed through the second quarter a little over 50 stores. If you recall, we had planned to close a little over 100 and some stores when we announced it at the beginning of the year. Of course, I'll remind everyone that we said that that number could shift through the year as we execute our rent reduction initiatives and to the extent we're more successful in getting more rent reductions, that could save stores if they turn cash flow positive. If we weren't as successful or just in the mix, we would look to adjust that number.

So the comment today was an update on where we think we'll be for the rest of the year. The majority of those 40 to 50 additional stores that we're going to look to close - and, again, they will close after the Christmas selling season - the majority are in the Fashion Bug brand and, as I mentioned in my comments, they are lease expirations that are occurring here as we move to the January 2010 number.

So I will offline get you the specifics, the numbers that you're looking for.

Ildiko Hilber - Waterstone Capital

Okay, just to make sure I'm clear, it's not 45 incremental store closures?

James P. Fogarty

Well, let me just add to that. So we remain, just to be clear, we remain very focused on conversations with landlords about our stores. We have pockets of stores; we obviously have pockets in Fashion Bug. When we talked about it we told you that we had an additional 45 stores that were put on the close hopper and Fashion Bug was a part of that.

But within Lane Bryant, Catherines', Fashion Bug, we have pockets of stores that are not cutting it for us and, just to be clear, we are having very direct conversations with landlords. We will close the store if we don't get the economics to make sense. Sort of simple, straightforward, full stop, that's how we are approaching our real estate. We have no desire that we have to be so big or so many stores. We just need to have as profitable and as effective a business as sensible.

We'd rather have more stores stay open. We'd rather have a bigger, more profitable business. But the landlords in those pockets of stores have got to work with us for us to be content with that answer.

Ildiko Hilber - Waterstone Capital

Sorry, if you could just clarify - the 45 stores you talked about, is that incremental to earlier plans of how much you wanted to close or is it just 45 more stores that will close to execute the original plan?

Eric Specter

It's the former. What we said today is that there was an incremental approximately 45 stores.

Through the second quarter we have 2,258 stores. As I mentioned, a little over 50 stores were closed in the first half of the year, and with this announcement today of an incremental 45, directionally we'll close 140 to 150 stores for the full year, meaning that we have another 90 to 100 to go against where we are at the end of the second quarter.

Operator

There are no further questions in queue. At this time I would like to turn the call back over to management for closing comments.

James P. Fogarty

Okay. There was one question that wasn't asked which I'll ask ourselves and answer, which is a little odd, I realize.

We were actually expecting people to ask us about Fashion Bug. Because what'll happen is people will ask us when we chat individually or meet with folks, I wanted to just, because we thought about it, I wanted to make sure you understood our thinking on it.

First, Fashion Bug is a turnaround process. And I've got some experience with turnarounds personally and we'll just make two quick points on it. First, there's no guarantees with turnarounds. Sometimes they don't work or they work and sometimes they don't work as well as you'd like.

Second, and very importantly, they require incredible, call it irritable patience. So they require us to have patience to see the strategies through, which we are absolutely doing, and they require us to be irritable along the way, which we are absolutely being.

And then finally, when we look at Fashion Bug, the very good news side of Fashion Bug - so long story short, we are optimistic on Fashion Bug. I want to be clear that we are optimistic and we think we're doing the right things because, first, there's a very large market space that that business sits in in that value-oriented plus consumer space. But negatively, there's a lot of fierce competitors in this space - Wal-Mart, Kohl's, JCPenney, etc., etc.

So to be successful we need to not just play it like they play it, but we need to have a carved-out niche for ourselves that works for us, one within which we can be successful. So that's what we're doing. When we talked about the strategy, what Jay and his team were doing, executing the strategy of focus around the missy and plus sizes, executing the strategy of lifestyle presentation.

And then we're excited about executing the strategy of price around, yes, having our everyday ticketed prices come down a bit and get to fair pricing levels, but keeping some margin so that we can drive what we expect to be exciting promotions as we move into late September and into the back part of this year in an item of the week kind of a fashion, where there's one sort of solid product that's got a really tight price point that creates excitement. You may have seen Old Navy pulling this move. So something like that move. We're going to do it our way, but it's going to create excitement.

So I wanted to just answer the Fashion Bug question and say that we're working it hard and we will keep you posted, but we're all going to have a lot of patience because we think we're doing a lot of the right things and we want to play it out. And at the same time, if stores don't make sense along the way, like Eric took us through, the incremental 45, we'll address that and make the core chassis more profitable.

So, with that, we thank you for your time today and we'll talk to you soon.

Eric Specter

Thanks, everybody.

James P. Fogarty

Thanks.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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