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Jones Apparel Group, Inc. (NYSE:JNY)

Q3 2009 Earnings Call

October 28, 2009 8:30 pm ET

Executives

Wesley Card – President, Chief Executive Officer

John McClain - Chief Financial Officer

Analysts

Todd Slater - Lazard Capital Markets

Robert Ohmes – Banc of America Merrill Lynch

David Glick - Buckingham Research

Ben Rowbotham - Goldman Sachs

Chi Lee - Morgan Stanley

Robert Drbul - Barclays Capital

Jennifer Black - Jennifer Black & Associates

Omar Saad - Credit Suisse

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Jones Apparel Group 2009 third quarter earnings conference call. (Operator Instructions)

On this conference call, the company will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 about its business. These statements are based on current expectations of future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

For a detailed discussion of these risks and uncertainties and other important factors that could cause actual results to differ materially from the company’s expectations, the company directs your attention to its Annual Report on Form 10-K for the fiscal year ended December 31, 2008 including but not limited to the statement regarding forward-looking disclosure and item 1A:Risk Factors therein, and to its other filings with the Securities and Exchange Commission.

The company does not undertake to publicly update or revise its forward-looking statements as a result of new information, future events or otherwise.

Before we begin, the company would like to point out that once again this quarter’s supplemental slides are available on the company’s website for download.

I will now like to turn the conference call over to Wes Card, President, and CEO; please go ahead sir.

Wesley Card

Thanks, Operator. Good morning, everybody. Welcome to our conference call to review the results that we released earlier this morning. I am pleased to report another very strong quarter. Earnings per share were well ahead of last year’s results and expectations. Over the past year, we have been very focused on our efforts to control inventories, manage costs and expenses, and leverage our scale. Our management team has been totally focused on this and has executed extremely well. This quarter’s results are evidence that these efforts are paying off.

Sales and orders were down but in line with our expectations. Customers had ordered conservatively for the third and fourth quarter, which I believe will be beneficial to gross margins for the balance of the year.

Along with the basic controls, we’ve been concentrating on developing innovative product and on various merchandising and marketing initiatives. We are benefiting from this in our strong brands. Our brands are at the right price points with the consumer so focused on value that much improved product assortments and exciting new initiatives samples in including Rachel, Rachel Roy and [Shoe-wu].

We continue to update and refine our vertical turnaround strategies and are making very good progress, which we will talk about in detail on the call. The operating margin was strong at 8.7% and ahead of expectations. That’s the result of very well managed inventory levels, buying close to demand, and very well controlled expenses.

All businesses improved as businesses stabilized during the summer and picked up into September and October, particularly with the cooler weather. Supply and demand over this period has generally come into balance and in general, consumer confidence and spending is improving. It’s starting to feel like the beginnings of the economic recovery although the signals remain somewhat mixed. I’m sure you all saw yesterday’s consumer confidence numbers indicating a slight dip off the prior month.

So we are still operating in an uncertain retail environment and holiday markdown activity remains a little unpredictable at this point. I believe it should be much improved. Lower stock levels across the industry should reduce the extreme markdown pressures of last year.

So with that, I’m going to turn the call over to John to run through the financial results for the quarter. John.

John McClain

Thanks, Wes. Good morning, everyone. This morning, the company reported its results for the third quarter 2009. On a GAAP basis, net income was $31 million and earnings per share was $0.36, as compared with net income of $27 million and earnings per share of $0.33 in the prior year. The remainder of my discussion will focus on the comparative operations of our businesses for the periods discussed and therefore all income statement related references or net results are on an adjusted basis unless otherwise noted. Adjusted results exclude the impact of restructuring costs, impairment charges, and certain other costs that we don’t consider part of our ongoing operations.

On an adjusted basis, earnings per share from continuing operations was $0.46 for the third quarter of ’09, as compared with $0.34 in the prior year. As you are well aware, this quarter saw the continuation of a very uncertain economic environment for most companies. Consumer confidence is unsteady, unemployment claims are rising and are expected to continue to rise for several more quarters, adding to the uncertainty. Customers are continuing to buy against this trend, which is translated into lower revenue year over year.

In response, we continued executing our strategy of focusing on our core competencies and streamlining our cost structure which, as shown in our results, continues to benefit us through these challenging times.

We also continued to execute on our retail improvement strategy, where we reduced our quarterly loss by about half or $10 million for the quarter and have closed 69 locations since the beginning of the year. The third quarter total company net revenues were $857 million compared with $965 million last year. This 11% decrease is reflective of the overall economic environment and is within the range given to you in July.

Considering the economic climate, we are pleased with the sales level. Total company operating income was $74 million versus $55 million last year and operating margin was 8.7% versus 5.7%. This improved was due to both an increase in gross margin of 200 basis points and a decrease in SG&A of about $38 million. Benefiting from our intense focus on inventory management, which is part of our efforts to control costs in all aspects of our business.

Before I discuss the segment results, I’ll highlight some balance sheet and cash flow items. Accounts receivable were $414 million at the end of the third quarter, versus $475 million in the prior year decrease of 13%. Accounts receivable turn on an annualized basis was 6.9 times, compared with 7.15 times last year and the portfolio remains very healthy from an aging perspective.

Inventory was $417 million at the end of the quarter versus $548 million in the prior year, a $131 million decrease or 24%. As we have been highlighting to you for several quarters we have and continue to work very hard on maintaining appropriate inventory levels relative to our sales plans and that those inventories remain current. The quality of our inventories continues to improve over the prior year. Inventory turn on an annualized basis was 4.3 times, essentially flat when compared with 4.85 times last year.

During the nine-month period, we generated $149 million of cash from continuing operations, which is a $141 million increase from the prior year where we generated $8 million. Year over year change is due mainly to a lower level of working capital requirements and tightened inventory controls.

Total debt was $537 million, down approximately $245 million from the prior year. This reflects the completion of the debt tender that we discussed last quarter where we repurchased approximately $242 million of the $250 million notes which were due I November 2009. Our revolver remains undrawn and we ended the quarter with approximately $157 million of cash as compared with $338 million at year-end. This decrease reflects the use of our cash to complete the debt tender and the related fees and expenses associated with our new credit facility. A ratio of debt to total capitalization net of cash was 23.7% at quarter’s end and that’s reflecting the impact of the debt tender.

During the quarter, we continued to execute on our retail improvement strategy through our continued evaluation of store locations and our expectations for the future, slightly adjusted the plan and now expect to close approximately 265 stores by the end of 2010, up from our previous estimate of 240 stores. This is due in part to our ability to successfully negotiate lease terminations that will allow us to close stores without incurring significant cash outlays. The anticipated mix of store closings will be about 50-50 between mall-based stores and outlet stores. By the end of 2010, outlets will represent approximately 70% of our store base.

Exiting these retail locations will result in the elimination of operating losses at the stores, which we now anticipate will benefit our financial results by $4 million in 2009, $16 million in 2010, and $22 million in 2011. We continue to be conservative when considering new store openings and expect future openings to be heavily weighed towards the outlet store concept.

We will also continue to test and evaluate new concepts like our multi-brand footwear and accessories concept.

Now I’d like to discuss the third quarter 2009 results for each of our segments and this information is included in the slides that we posted to the website today.

For the quarter, wholesale better apparel revenues were $287 million compared with $351 million last year, consistent with industry trends for women’s apparel. Sportswear Jones New York continues to perform well across the channel and in suits and dresses, revenue performance met our expectations with increases in both Jones and Evan-Picone dresses and in Evan-Picone suits and in suit and separates.

Operating profit margin improved to 14% in 09 compared with 10.4% in ’08. The margin improvement reflects improved merchandising and sourcing, benefits of inventory and expense controls, and the absence of bankruptcy bad debt charges.

In wholesale jeans wear, revenues were $205 million compared with $204 million last year, a 1% increase representing a slight increase in the sale of bottoms. Segment operating profit margin improved to 11.4% this year, compared with 6.1% last year. And profit margin improvement is primarily due to improved merchandise planning, benefits of inventory and expense controls, and the absence of the bankruptcy bad debt charges.

Wholesale footwear and accessories revenues were $242 million this year versus $297 million last year. Revenues in each of the businesses in this segment were down as the challenging economic environment continued to impact orders.

Segment operating profit margin was 12.6% compared with 10.3% last year. Profit margin improvement is primarily due to the benefits of inventory and expense controls and the absence of bankruptcy bad debt charges.

As I mentioned last quarter, the restructuring of our jewelry business has resulted in improved performance and the operating profit margin for the jewelry business in the 2009 third quarter was higher than 2008.

In retail, revenues were down -- excuse me, were $167 million compared with $173 million last year. Revenues were down due to a lower number of stores and a decrease in same-store sales of 3.2%. Same-store sales in footwear were down 5.4%, which consists of a decrease in malls, footwear malls of 10.6%, and footwear outlets of 1.2%.

Apparel same-store sales were down 5.2% and our web business, comp sales increased 45%.

During the quarter, transactions were down 2.4% and our AUR was flat. Segment operating margin was negative 6.2% versus negative 11.5% last year. Here, results improved as lower inventory and cost controls offset the impact of the sales decline.

Our 2009 guidance will continue to focus on the certain indicators of performance and should be somewhat more predictable even during these uncertain times. Based on our current view, we believe that the company net revenue should range from $3.31 billion to $3.34 billion. Here we’ve tightened the range on both the bottom and the top. On a segment basis, we forecast revenue in the following ranges -- better apparel of $1.05 billion to $1.06 billion; jeans wear of $825 million to $835 million; footwear and accessories of $890 million to $900 million; and retail of $685 million to $695 million, reflecting fourth quarter 2009 comparable store sales in the range of negative 2.5% to positive 2.5%.

This results in full-year 2009 comps in the range of negative 4% to negative 5.5%. That’s compared with 2008 full-year results of negative 4%.

Coming back to consolidated guidance, second half revenue comparisons are more difficult than the first half comparisons. We expect that the fourth quarter revenue numbers built in these projections will be down 7% to 10%.

Additionally, for full year 2009 we are forecasting SG&A expenses to be lower than 2008 by about 8.5%, or $90 million. During the course of the year, we’ve reduced a significant amount of SG&A through efficiencies. We will continue to work on additional efficiencies in the future but we also expect to see some inflationary pressures.

We will also expect to be selectively granting salary and wage increases next year, which we did not do in 2009, and we do expect to see some other cost pressures.

Other guidance assumptions are included in the slides that we posted to the web today.

A couple of final items to assist people on their financial models -- first, as related to earnings in the back half of the year, our third quarter historically tends to be a high margin quarter and consistent with that, our gross margins and operating margins were both strong this quarter. Given the current economic climate and the level of promotions that have occurred over the past few years, and the concern that the consumer is now expecting and waiting for holiday promotions, we believe gross margins and the resulting operating margins are very difficult to predict for the fourth quarter. Historically gross margin in the fourth quarter are lower than the third quarter. Last year the difference in gross margin was 390 basis points due to last year’s fourth quarter including severe markdowns. The difference in gross margin in 2007 was 170 basis points and we encourage you to keep these trends in mind.

Second item is the change in an accounting rule related to unvested restricted stock, which I did mention during our last call. Under the current rules, we must allocate a portion of our earnings to our restricted shares and that’s about 4% of earnings that need to be excluded. I want to remind folks of that, since I’m not sure that all the models have reflected this correctly. If there are any questions on this, I’d be happy to answer those after the call.

And finally, based on current business trends, our operating cash flow should exceed $200 million, up from our prior estimate of $175 million due to our strong control over working capital. While operating margins are difficult to forecast, we’ll continue to conserve cash through tight inventory and spending controls.

Factoring in capital expenditures of about $30 million and quarterly dividends of $0.05 a share, which total $17 million for the year, the resulting free cash flow target is in excess of $150 million, which excludes the impact of the debt tender, the ABL, and our additional investment in GRI. We expect to end the year with about $200 million in cash, nothing drawn on our revolver, and no debt coming due for about five years.

That concludes my comments and I’ll turn the call back over to Wes. Wes.

Wesley Card

Thanks, John, and I’ll briefly cover the activities in our various reporting units. First, wholesale apparel -- better sportswear has been a strong performing category so far this fall and operating margins were better than we had expected. Our collection is performing much better and we are very pleased with our progress and results. While orders were lower, new assortments and products on the floor are performing well and exceeding store plans. For spring 2010, we just introduced a collection of career knit products. Customer orders and reaction was very strong for this product and we are going to get great placement as we roll into spring.

Jones Signature is growing and continues to perform well. As an adjunct to that, for spring 2010 we also introduced a soft and relaxed casual dressing collection, which we have branded J by JNY, which our customers agreed was a white space on the floor for this product and that separate branding and funding was appropriate. We’ve got very good placement for this product as well and we should have substantial presence on the floor again as we roll into spring.

Anne Klein product continues to improve. We are beginning to note some encouraging results. Spring 2010 plans are down here based on the performance over the year but we are starting to solidify this positioning. Based on the product now in the stores, we believe we are getting very close to aligning the product, store positioning, and the pricing and continue to target a somewhat younger working woman versus the Jones New York customer and we are hopeful that we are on a good track there and we’ll see some good results for spring.

[Nima’s] Sportswear is a brand that we elected to put on the shelf for a few seasons. We made this decision just prior to the spring markets. As we approach that market, we felt we just weren’t ready and needed to regroup to reintroduce that product. It’s a very small sales volume, not profitable, so that will have little or no impact on our results and it is a product that we plan to reintroduce several seasons down the road.

Suits and dresses continue to be strong. The inherent value fits into today’s economy and dresses, particularly in the warmer weather periods, have remained a very strong fashion trend.

Rachel Roy, a business we’ve talked a lot about, the designer component of that is a very small business. It’s also very important as an umbrella for the brand. We continue to support this in a tough climate for luxury but that allowed us to launch the Rachel Rachel Roy line which we launched in Macy’s in August. We’ve had very strong sales performance to date, as I am sure you’ve heard. This launch was supported with many social marketing initiatives -- Twitter, Facebook, blogs. We opened a pop-up store in New York City for several weeks which allowed us to showcase this brand in the key contemporary shopping area in New York City, and we are just off to a great start with this brand in 85 doors, which will increase to about 140 doors for spring 2010.

Turning to wholesale footwear and accessories, footwear business is just very strong overall. Boots have been exceptional, a clear fashion trend for this season, particularly it started early in the summer but as the weather cooled, it became even stronger. All of our brands are performing in this category and we also noted improved operating margin in this segment for the quarter.

Nine West is back in Nordstrom for all doors for spring. We had a several year hiatus there and we are very pleased to be reintroduced into Nordstrom for next year. The Nine West vintage America product was launched in August and off to a great start. The casual and western style boots which are a key element of the product for fall are right on trend and performing very well.

Easy spirit has been a good performer. We have an anti-gravity shoe, which fits in with that new fit type shoe concept and just white shoes in general have been strong. Our styles are doing well.

So overall footwear just has been one of the best categories for fall. As part of this segment, we also market handbags. Here the business has been okay, a little bit slower category. I think the recent very strong trends in handbags have been so strong that the consumer is just taking a break here and really focusing on updating footwear, and particularly in to the boot categories. But business generally okay in the handbag area.

Custom jewelry, another part of this business, is improving. We have new management, new direction in this division. We’ve cleaned out the old stock, started fresh in third quarter and seeing good results from the new products. And although this is a small division, we had been losing money whereas the turnaround efforts have returned the division to profitability in the third quarter and our outlook is now much improved for this part of the business.

Turning to jeans wear, wholesale jeans wear also posted very strong results for the quarter, good operating margin improvement. The core business here is Gloria Vanderbilt, a very strong performer across all the mid-tier channels, shipping now new extensions of products, including a dress pant program and some separate sportswear items. Both look encouraging as that brand continues to develop.

Energy junior top business has stabilized, results are starting to improve, and I think the changes that we have been making for the product assortment are really starting to take old. The product is much more exciting and innovative, much more embellished, which is on fashion trend and the spring market for that brand was very good.

l.e.i. Walmart, that relationship continues to be very strong. The product is excellent, it continues to perform well. There is some new competition coming into juniors, as you know, which have rotated into some of the hot spots that we enjoyed last year in our introductory period but overall business there is solid and continuing on a good trend.

Turning to vertical retail, John covered some of the details of our strategy here. Results improved a lot. The loss was narrowed considerably over last year and the strategy is right on track. Very pleased with the way the store closures are being executed. It’s not having a major impact on operations and we can still see some improvement as we close doors and liquidate that stock.

We started this year with a door count of 1,017 doors. We’ll be down to probably 911 doors by the end of January 2010, so we -- and then down just under 800 doors, 775 by the time we finish 2010, which is the track that we’ve talked about.

We continue to look at this and evaluate this store base realistically and fine-tune the closures and assess other opportunities as we move forward. One of the experiments we are working on, as you know, is the [Shoe-wu] concept, which is a multi-brand footwear store. We just opened a flagship location in New York City on Lexington Avenue, right across from Bloomingdales. That location is performing extremely well. It’s garnering excellent traffic. It’s comped up 18% in the four weeks that it’s been open versus the former Nine West door on that same location, so we are going to be watching that very carefully to determine if that trend continues. We expect about six doors open by the end of the year and I think early next year we are going to have a good sense as to whether this can be a chain that meets our financial characteristics and requirements, as well as a good opportunity for growth moving forward.

E-commerce, John noted was up on a comp basis 45% for the quarter. The total business was up 58% as we’ve introduced new concepts. All sites have been increasing in sales. The inventory fulfillment systems, which tie into the total inventory in our chain, have been a big plus in allowing for better close-out of sale goods. We launched Rachel Rachel Roy on the website in August. This markets all of Rachel’s products and again is really integral to the marketing efforts of that brand.

I feel we are still on track to increase sales from last year, $32 million in total web-based sales to just about $50 million for 2009 and we should be able to build on that again in 2010.

So in general, I am very pleased with the third quarter performance and our continued progress. I am cautiously optimistic about the future, as we work through this economic recovery, we’re just going to continue to control what we can control. Our brands are priced in the sweet spot at today’s economy and as you know in these times, customer loyalty is critical. Consumers tend to return to quality brands that they trust and value, and I can proudly say that our products have never looked better across the entire company from top to bottom. We are also diversified across various distribution channels and brands, also critical and difficult periods. I think even though we are in difficult times, there are still opportunities in the market even today and we are investing in those opportunities. We’re getting floor space based on the strength of performance and as some competitors have exited in the better zone -- examples, the Jones New York brands are getting good positioning, good placement on the floor, Nine West back in Nordstrom, another indication of where we are gaining positioning.

We continue to challenge ourselves to constantly update the merchandise and innovate. Again, examples, Jones New York knit collection, the J collection, Vintage America for Nine West, Rachel Rachel Roy, [Shoe-wu] -- so we continue to innovate and experiment with new ideas and we have phenomenal relationships with our key department store customers that we continue to build on as we move forward.

I think with the strong financial position, we are currently seeing many new opportunities that are coming to us to utilize the various core competencies and hopefully provide for growth and market share gains as we move forward.

Finally, just one word of thanks to the management team and all of our associates, they have continued to perform superbly in a very difficult period and are more energized than ever as we work into the economic recovery.

So with that, Operator, I think we are ready to open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Todd Slater of Lazard Capital.

Todd Slater - Lazard Capital Markets

I have a few questions, so I’ll just list them, starting with the Liz move out of Macy’s into Penny’s. How does that affect Jones in the department store channel and is there any kind of an offset in Penny with Jones wear?

And secondly, what are you guys thinking on the market size opportunity for Rachel Roy, given initial success and for the rollout?

And then I have a question on the retail side, given all the improving footwear trends you noted and the restructuring that you’ve done there, does the retail segment, any reason that segment shouldn’t turn at least a small profit in the fourth quarter?

Wesley Card

I’ll start with the last one first. I think that the guidance that John has given for the year probably would indicate that we are going to be break-even or hopefully have a profit in the fourth quarter. I think some of that is going to depend on how the consumer responds. We are cautiously optimistic the way the consumer is buying it. We are going to continue to have a strong fourth quarter, so we will see how that plays out but I think there’s a good chance that we will be in the black in Q4.

Todd Slater - Lazard Capital Markets

Wes, could I just follow-up -- does that mean sort of the low-end of that range down 2.5% comp would be sort of represent a break even and the higher end would represent some profit there?

Wesley Card

Well, I think a key element there, it’s not so much the comp. What we are seeing, and I think it’s across the board as stronger gross margins and lower expenses, so I think that it’s going to be the strength of the markdown, as opposed to just the relative comp. I think -- and that’s what we have seen as we have come through the summer. Inventories are very well controlled -- in fact, we are I think finding ourselves in a position many retailers are of even being a little bit understocked in selected spots and I think that’s a good thing right now. I think everybody -- it’s better to be on the low-end than to have pushed for a higher growth and just had more markdowns, so we’ll see how that rolls out.

With respect to Liz, I think Liz was in limited distribution in department stores in any event and was shrinking. We are taking advantage of that. We are going after different programs, primarily in the Jones New York sport division, which competed probably closer to Liz. And I think we are going to pick up some good orders as a result of that.

Penny’s, I don’t see any effect on Jones Wear. Jones Wear is a very focused traditional line and Penny’s, it’s performed very well for them and I think we will hold that position. I don’t think that is going to have an impact on that. If anything, it could -- new labels and things, it could enhance the overall performance of that brand.

Rachel, it’s hard to define the total market for that product. There’s just so many things happening an we are so excited about the initial penetration and the selling, which is way ahead of the store plans on the first seasons, even including re-orders that they did and some rapid re-order we made into fourth quarter fashion items.

We are going to roll from 85 to 140 doors, as I mentioned. I think we will be up 180, 190 doors for second half next year. We are moving slowly and carefully because as you would expect, the more door rollout, the more you get anomalies within the rollout, certain sections in stores performing extremely well, others you need to rebalance and move into different areas. So its’ a good learning experience for us. I think we are happy that it is selling through very well and that the average unit retails are very strong there, which is also encouraging and I think we’ve got Macy’s strongly behind us and I think we’ve got a great future there.

Operator

Your next question comes from Robert Ohmes of Banc of America Merrill Lynch.

Robert Ohmes – Banc of America Merrill Lynch

A couple of questions -- the first, Wes, can you just sort of broadly talk about spring 2010 bookings, the overall tone sort of versus fall ’09 and I think a lot of us are wondering when could we see the revenue start to come back so we are seeing the gross margins come back on the tight inventory planning but when do you see the revenues coming back with your wholesale customers?

And the second question, I was wondering if we could get a little more info on l.e.i. -- you mentioned the shift in the positioning at Walmart. I think you guys are losing Taylor Swift -- is this still a growth business for you or does it flat line here, and what does the profitability look like? Thanks.

Wesley Card

I’ll go with the first question first on the orders -- if you’ll recall, first quarter was a very strong sales quarter for us. Retailers had ordered first quarter well before the very extreme financial difficulties set in last October, so I think that’s going to be our toughest comparison. We are thinking just directionally, we have many of the spring orders in at this point but we are still finalizing in a lot of areas. I think directionally we are going to be down in the mid-single-digits, a much improved drop over where we have been trending this year.

I think as we go into second, that could be a really interesting quarter for us and remember too that first quarter is largely driven by clearance in the months of January and February but second quarter of the new spring, fresh summer goods that hit the store and where retailers have had much better retailing over the last few years. I think second quarter could be interesting and I think that what we are encouraged on signs that our businesses have bottomed out and can start to grow off this base as we get into second quarter and certainly the back half of next year, based on what we are seeing in some of the early thinking we are sharing with our retail customers. So we will see -- I think we are encouraged by that and economic recovery, if it continues and things continue to brighten, certainly will fuel that. I think particularly with a lot less stock coming into next year. I think we could be in a really good position to start showing some growth.

Turning to l.e.i., we continue to strengthen on the part of the business that we are shipping, you know, we’ve grown to I think just about $270 million in gross sales. We are not going to be repeating in the hotspots which will impact that a little bit. With licensed businesses continuing to grow around it, I think we are going to continue -- we will see growth there as we intensify that brand. Walmart, as you know, has also introduced a Miley Cyrus line into that floor, which has taken up the hot spots for this current season.

I think going forward next year, what we are seeing there is a tremendous price pressure from Walmart. Their stated strategy is to be the low price provider and we are certainly reacting to that and you know, we’ll have to deal with that as we move forward. But I think overall, their business is strong and we will continue to be a solid performer in Walmart with them. Profitability has been good, as I can only talk to the segment, if you look at the segment operating results of this quarter, up in the high-single-digits. You know, better than we had originally thought we would get to so we are -- and this is a component of that, so we are pleased with where we are performing in the overall jeans wear segment.

Robert Ohmes – Banc of America Merrill Lynch

Great. Thanks a lot.

Operator

Your next question comes from David Glick of Buckingham Research.

David Glick - Buckingham Research

I appreciate the color on spring 2010 because that was really my question but in the interim, as you anticipate that hopeful turning point in the second quarter, what is your ability to chase business in the near-term? And what I mean by that is your ability and are you strategizing to have at least the option to accelerate orders by 30 days as retailers hopefully will be scrambling a little bit more to get goods in the store. And then what kind of position are you taking on replenishment which on the sportswear side, perhaps in bottoms, the ability to do that but I would think in footwear there could be some opportunities to make -- maybe take a little bit bigger position from an inventory position without a lot of additional risk.

Wesley Card

Well, I think, starting with the last part of your comment on footwear, where you have a little bit shorter cycle, we are reordering into deliveries for late fourth quarter and into January because I think the way boots and some of the other fashion items are performing, there’s going to be a need for those items even at clearance, because January is a primary clearance month. There’s going to be a lot less clearance -- there already is a lot less clearance on the floors in retail in general, as well as in our stores, so that the level of discounting while the cadence is still there on the events and normal promotions, the level is just not getting so deep, so they are going to need goods just to promote in January and February, so we are reordering into that. I think that’s a normal cycle. We do have some very strong performing replenishment products in the Jones Collection area -- the platinum series is performing extremely well, so we continue to fill those stocks in. There’s some shirt programs in signature and others that we are constantly replenishing. So those are good areas.

I think that where we are short is and where we probably -- everybody wished they had more goods was in some of the fashion areas but I think that’s a good thing. The cycle times on fashion product are longer and developing special colors, fabrics, and styles, there’s a much longer lead time because you are working with the raw materials. That’s our competitive edge, so I think that’s a good thing for us to constantly be discussing with our customers. If we don’t order certain fashion items now, we are not going to have it and I think now retailers maybe wish that they hadn’t cut back quite so much in the fourth quarter.

In the aggregate though, I think that’s a good thing because a little bit of scarcity is good for the consumer. If they start to feel like the item they really want is not going to be there when it goes into a deeper discount, they are going to respond. I think they are already doing that a little bit in the boot area and other areas. We are just seeing relatively strong demand against albeit lower plans but good demand against that, so I think that is right where we want to be and we react wherever we can to fill in.

Over the summer, by the way, the stores did -- were working on certain programs to beef up in the fourth quarter, which we were able to do as we worked through fourth quarter. I think overall we are in a good spot. I think scarcity is not a big issue. I think that’s going to play well for both -- for the whole industry.

David Glick - Buckingham Research

And the goods that you are chasing on, could that have a measurable impact on your top line in the next couple of quarters where we now have a little better visibility on your sales trend? And is it enough to move the needle 100 or 200 basis points on the top line?

Wesley Card

That’s a pretty big number. I don’t think the top line elasticity is really the key -- it’s really the gross margin. If we could feed in both late fourth quarter where we can and then into first quarter, we are going to have a much better gross margin line. Even if our sales are down in the mid-single-digits, I think we’ll be in a good spot margin and inventory wise and then you transition into summer, which is where I think people are going to be focused on that April/May period when business is usually really strong as you get into the seasonal items.

David Glick - Buckingham Research

Okay. Thanks very much for the color and best of luck to you.

Operator

Your next question comes from Ben Rowbotham of Goldman Sachs.

Ben Rowbotham - Goldman Sachs

Thank you. I was hoping you could maybe talk a little bit about the SG&A, you know, provide a little bit more detail on where the incremental cost-out efforts are coming from and the permanent nature of them. And then I have a follow-up on [Shoe-wu].

John McClain

As we’ve said before, we are always looking and working very hard to find efficiencies and we continue to do that, so we’ve seen improvements in distribution and we will continue to work those. I think the investments that we’ve made in systems over the past number of years are also continuing to pay dividends as we find better ways to do things internally and get better information, so those are the areas where we continue to have successes and we will continue to look for more opportunities.

With the way that we’ve gone about attacking the expense numbers, we’ve done it in a very thoughtful way. We’ve taken out these costs and we really got a good base so that we can continue to grow from here without having to add back a lot of costs.

Ben Rowbotham - Goldman Sachs

Thanks, that’s helpful. And then on [Shoe-wu], I know it’s early but just given the success that you’ve seen, if you do choose to roll that out, how would you go about doing that? Is that going to be more new build or conversions?

Wesley Card

Well, we’ve got a lot of opportunity for conversions and I think that also -- the beauty of that is it gives you a chip to bargain with to do good conversions where you’ve got an underperforming door and you -- but you need a larger door for a [Shoe-wu]. You can do a conversion and you get support from the operators in terms of build-out and rent and different ways, so I think it puts you in a good bargaining position because as you would expect, the mall operators and shopping center operators are looking for new concepts and for growth in this kind of a climate.

But I think that’s one of the benefits, we think, is going to be being able to convert really well, which will help both the existing operations and then put us into a new more, much more productive store base.

Ben Rowbotham - Goldman Sachs

Great, thanks again and best of luck.

Operator

Your next question comes from Chi Lee of Morgan Stanley.

Chi Lee - Morgan Stanley

Looking at your fourth quarter comp guidance, down 2.5 up 2.5, can you just comment how the quarter has started? And if you could just give us detail between value and mall, that would be great as well.

John McClain

Month to date, where we sit today we are down about a percent in total and as we compare that to the third quarter, we are really -- we’re a little better in footwear mall, a little better in footwear outlets, better in web, and not -- and down in the retail -- excuse me, in ready-to-wear.

Chi Lee - Morgan Stanley

Okay, great. And then just going back to your prior comment in terms of Walmart and its pricing for next year, how much of that do you think you can fund, given the cost environment that you are seeing right now? Are you still seeing the deflationary benefits to really help you fund whatever it is in terms of the pricing reductions Walmart is asking for?

Wesley Card

Well, I think with Walmart, with the size of that business, you have a scale so you can probably wean more out of the sourcing base than you could with smaller product lines, so I think that goes in our favor.

I think generally costs have sort of flattened out and if anything, I think as we get into the latter part of next year, it feels like we are going to start seeing some cost increases. I think people are starting to see raw material prices strengthening, businesses starting to pick up a little bit and I think we could start to see the business overall sourcing base in China business has been starting to pick up manufacturing wise. Their economy seems to be recovering quicker -- well, it never really went into recession but had a dip. They are bouncing back stronger so I think we are going to see firming of costs and prices as we go forward, so we are going to have to engineer as hard as we can to maintain margin and we will see. I don’t think that’s so much of an issue for the first part of the year but it will be more so I think as we get into the latter part of next year.

Chi Lee - Morgan Stanley

Okay, great. And then my last question just in terms of the consolidated fourth quarter revenue guidance, how much or what type of a markdown scenario is really baked into that guidance? Are you guys assuming any improvement in what you guys have to pay back for the fourth quarter relative to perhaps the first three quarters of this year?

John McClain

It’s a little bit better compared to last year but it’s on the same track as we’ve seen this year, Chi.

Chi Lee - Morgan Stanley

Okay. Thank you.

Operator

Your next question comes from the line of Robert Drbul of Barclays Capital.

Robert Drbul - Barclays Capital

I guess the question that I have is you talked about the re-entry into Nordstrom. Just how big an opportunity is that for the Nine West business?

Wesley Card

We don’t quantify on a customer basis and I don’t -- it’s a pretty substantial number if you think of the number of Nordstrom doors but we just don’t quantify individual customer penetration in dollars.

Robert Drbul - Barclays Capital

Will it be -- do you think it will cannibalize anything that you are doing with any of your other partners or do you think it will be incremental sales volume?

Wesley Card

I think it is going to be incremental because one, Nordstrom has a very impressive shoe business, as you know. We are working to differentiate that product with them as well as against other competitors and their competitors, so we are trying to broaden the line and make sure that we’ve got interesting and differentiated selections in all the stores, which as we do as a matter of course in all of our businesses, so I think it’s just going to be a plus. Nordstrom is a tremendous operator. I think it’s going to help all of the businesses. I think it’s a real testament to the team at Nine West and what they have done with the product because that’s a very impressive move for us.

Robert Drbul - Barclays Capital

Great, and the last question I would have is on the store closure program, is the 265, do you think that is the final number of store closures, John, or are there additional ones that you are still looking at that are possible? How should we think about that 775 number ending in 2010?

John McClain

We work that portfolio all the time -- things change, you get different opportunities, so we’ll never stop looking for those opportunities, Bob, but it’s tough to predict.

Wesley Card

I think it’s probably close to where we will end up than when we first announced because I think we are kind of set on where we are going to end up. What we are really ending up with, if you break it down, the key components will be Nine West mall based stores, Easy Spirit based mall doors, Nine West and Easy Spirit outlet stores, Jones New York outlet stores for apparel, and Casper and maybe a few Anne Klein’s doors. That’s what we are going to end up with on a base and I think we really focused in on the concepts that work, that we know Bandolino’s full-priced stores, for example, those just didn’t work from the outset. We are going to be very much more focused in location and by brand and I think we are going to be in a pretty good spot.

But I think we are closer to the actual number now. I don’t see major movement although we will continue to tweak it.

Robert Drbul - Barclays Capital

Thank you very much.

Operator

Your next question comes from Jennifer Black of Jennifer Black & Associates.

Jennifer Black - Jennifer Black & Associates

I have just a few questions, most have been answered. I wondered if how many potential doors there are that you would consider converting to [Shoe-wu] -- if you have any idea, I know it’s very, very early, and what are the costs associated with converting? That’s my first question.

Wesley Card

I’m really hesitant to put a number on it until we get further along through the test and we can quantify it, make sure we have hurdle rates that we want to make sure we make. We need some further testing and I think this fourth quarter is going to give us a lot of information. So we will have that part of the question I think for the next call.

The build-out is a lot less than -- and again I don’t really have numbers for you but it’s a very cost-effective format because what we are doing is we are taking the basic four walls and we are painting them and decorating those walls but then nothing is built in, there’s no shelves -- all the shelves and components of the store are movable -- cabinets, tables, different interesting racks and ways of displaying the product that don’t require a lot of build-out for individual engineered stores everywhere you go and when you have seen the store, you get a better sense of -- I think you’ve probably seen it. When others see them, they will get a sense of what we are talking about, so they are pretty cost-effective to build out, to keep updated and keep in good shape. But we will have more detail when we are ready to say we are moving forward and rolling things out.

Jennifer Black - Jennifer Black & Associates

Great. Very cool stores. And then just one follow-up with that -- do you have anything that you can call out, any learnings about consumer behavior with the difference between [Shoe-wu] and your other footwear concepts?

Wesley Card

Well, I think what they seem to be responding to is they love the environment because it is very modern and fun and it is just a fun place to be. I think they are seeing brands all together in a spot, they are seeing the best of these brands and a good variety of items, so they seem to be responding well to just having multiple brands in a spot as opposed to just one brand. It really captures their attention as they move through the store.

The other behavioral piece is we arrange the store so you can't go up one side and out the other. You have to walk around fixtures and tables which requires you almost to browse. The -- so I think we are just seeing sort of a fun and excitement of something new and different and multi-brands in one spot.

John McClain

I think the high fashion items are doing really well -- the other thing we’ve seen.

Jennifer Black - Jennifer Black & Associates

That doesn’t seem to be surprising. Can I just ask one other follow-up question? You talked about the jewelry business and that there’s changes being made by the new management in place. Is there anything to call out at this point in time?

Wesley Card

Well, the first thing I didn’t mention on the Rachel part, the Rachel jewelry that they are doing is getting great receptions, selling through well and we are getting increased cabinets in the various stores. Nine West has been updated. The [Gavachi] line is doing -- all the product lines have just been updated and we are working -- part of the restructuring is working more direct with the far east and not through domestic operations, so the business is focused on I think quicker turning and just better product pretty much across the board. We are seeing good results in all of the jewelry line, so the costume jewelry has picked up as a category. It was not a great category last year in the holiday season, as you’ll remember but it’s starting to pick up in general, which makes sense in this environment that people are updating outfits and wardrobes with sort of fun, less expensive items. And I was surprised that it took so long to get going but it seems to be picking up just as a category. I think it’s going to be a good category for fourth quarter as well.

Jennifer Black - Jennifer Black & Associates

Great. Thank you so much and good luck.

John McClain

Operator, this will be the last call.

Operator

Thank you, sir. Our last question comes from Omar Saad of Credit Suisse.

Omar Saad - Credit Suisse

A couple of questions -- one on the expense side. You guys have obviously done a really great job controlling costs and reacting to the environment. How do you think about ramping that up again as you look at next year and beyond, and you think about how to build the business and where you need to invest and where you can stay lean? How should we be thinking about a ramp-up in the context of a recovery?

Wesley Card

I’ll let John talk about what we are seeing next year but I think what we see are two factors -- one -- or maybe three -- inflationary pressures are going to start to build. We are going to have to start giving some salary increases again. We didn’t do that this year. We are going to need to fund that, medical costs are going up, so we are going to see some of that. We are continuing to invest, so even though we cut we actually invested millions of dollars in the Rachel line this year, both in design talent -- we brought in a totally new design team, in the marketing programs, in the website, in the selling and production teams. So we are investing in new concepts that are being offset by other efficiencies and the third factor is as we centralize even further on the systems that we put in place, we are going to see continued efficiencies in both distribution, back room, and operations part of the businesses and we are actually way ahead of where we thought we’d be on gaining those efficiencies.

But I think in marketing, we are spending where we think it’s appropriate. We’ve cut out some of the -- what we thought were maybe unnecessary, particularly in this environment, real national image ads. Our brands are much more consumer focused in terms of direct marketing. We’ve kept a lot of that in the budget. We are doing a number of programs that are driving business. We use Lloyd Boston to do events in Jones New York. We have people doing events in other brands. We have the web and social media that we are using, so I think we’ve been pretty effective and wise, given the nature of our brands and how we are investing in spending, and I don’t see major infrastructure needs for the future either, in terms of systems or building out new distribution centers. People are doing things in different ways now and our systems are allowing us to take advantage of that.

That’s kind of a long-winded approach but I think on balance, we don’t have major new investment coming in unless we undertake new initiatives such as Rachel, where we do need to invest in different staffing and people in order to make it happen.

John, anything you would add to that or --

John McClain

I think you said it very well, Wes. I think the other area we’ve talked about over time within distribution are ways to ship differently than we do today and we’ve talked about how we can split containers and ship some, bring some in through the east coast and west coast, which reduce costs for both ourselves and our customers. Those continue to be opportunities. They are difficult to get to. We are working very hard at doing those and those will be big areas that will benefit us but that’s still out a bit in the future.

Omar Saad - Credit Suisse

Okay, that’s actually very helpful. And then to follow-up on the -- a quick question on the inventory side, minus 24%. Obviously that’s off the charts clean on a year-over-year basis. How do you think about it again in the context of a recovery, rebuilding inventory? Obviously you can't -- it’s hard to grow sales when the inventories are down 24%, even though your cycle times and turns have improved so much. How do you think about planning for inventory to the extent there is going to be a recovery in sales and at some point will grow again?

Wesley Card

Well, you know, our inventories turn over seven times a season, five times a year. So you think of cycle times, what we are going to ship in for whatever we are going to ship in February hasn’t even been put on the water yet and it’s not in our inventory for quite some time. But we’d be more than glad to invest in growth on inventories. I think John and I both feel we’ve leaned them down to I think almost optimum. We are going to continue to work on pockets within that and all nickels and dimes and make sure we stay in control and keep turning rapidly, we start to grow again.

I think it’s an investment we will gladly make if we see the growth.

Omar Saad - Credit Suisse

Okay, but you are not making that judgment now at this point?

Wesley Card

What judgment?

Omar Saad - Credit Suisse

To rebuild inventories.

Wesley Card

We are almost producing inventory to orders but we make that as we get our orders. We are matching up very well against demand. As soon as we see orders tick up, we’ll -- we increase the buys. I mean, it’s cleaning out -- what we have done really well is this year we planned very early on we took a very conservative posture and so our supply and demand matched up very well. We have very little excess. The excesses are being moved very rapidly and we really don’t have enough goods to keep everybody happy at this point in terms of the off-price suppliers. They want more excess goods, we just -- we are very clean and I think that’s a position that shows up in the gross margin very strongly and that’s where we want to be.

Omar Saad - Credit Suisse

Right.

John McClain

We are going to continue that discipline. That’s our approach.

Omar Saad - Credit Suisse

Got it. Well done, gentlemen. Good luck.

Wesley Card

Okay, well I guess that was the last question, Operator, so I’ll wrap up. Thank you all for your participation this morning and we look forward to keeping you updated as we go through this important holiday period. Thanks.

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Source: Jones Apparel Group Q3 2009 Earnings Call Transcript
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