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Kenneth Cole Productions, Inc. (NYSE:KCP)

Q3 2009 Earnings Call Transcript

November 3, 2009 4:30 pm ET

Executives

James Palczynski – IR, Integrated Corporate Relations, Inc.

Jill Granoff – CEO

David Edelman – CFO and Treasurer

Analysts

Scott Krasik – CL King

Jeff Van Sinderen – B. Riley

Sam Poser – Sterne Agee

Janet Kloppenburg – JJK Research

Mark Cooper – Wells Capital

David Berman – Berman Capital

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2009 Kenneth Cole Earnings Conference Call. My name is Amicia [ph] and I will be your operator for today. At this time, all participants are on a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions)

I would now like to turn the call over to Mr. James Palczynski. Please proceed.

James Palczynski

Good afternoon, everybody. Before we get started, I’d just like to remind you of the company’s Safe Harbor language. The statements contained in today’s conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results might differ materially from those projected in such statements, due to a number of risks and uncertainties, including but not limited to, demand and competition for the company’s products; the ability to enter into new product license agreements or to renew or replace existing product license agreements; changes in consumer preferences or fashion trends; delays in anticipated store openings; and changes in the company’s relationship with retailers, licensees, vendors, and other resources.

The forward-looking statements contained in today’s call are also subject to other risks and uncertainties that are described in the company’s reports and registration statements as filed with the Securities and Exchange Commission.

With that out of the way, I would like to now like to introduce you to Jill Granoff, company’s Chief Executive Officer.

Jill Granoff

Good afternoon and thank you for joining us to review our third quarter results. With me today is David Edelman, our Chief Financial Officer.

I am pleased to report that our business returned to profitability in the third quarter and we are seeing continuing improvement in the fourth quarter. We are making progress against each of our six key strategic initiative and our financial results while still unacceptable were better than expected. David will walk you through the numbers for the third quarter and share our guidance for the fourth quarter in a few moments.

But first, I would like to take you through some of our key business highlights since our last call and provide an outlook on the future. Our focus on quarter-over-quarter improvement is beginning to yield positive results. While we are continuing to experience top line pressure particularly in the wholesale segment, our heightened focus on inventory and expense management has led to improved gross margin and increased profitability.

Our net revenues in the third quarter were in line with guidance. Reported revenues declined 21% to $104 million versus $132 million last year, driven primarily by an expected drop in wholesale sales as we exited certain unprofitable lines and reduced oil price distribution.

Our consolidated gross margin rose 220 basis points versus the year-ago quarter. This improvement was the result of cleaner inventories, better product, fewer promotions and tighter distribution. We expect this gross margin improvement to accelerate in the fourth quarter.

Our consolidated inventory position was down 36% versus the same quarter last year. We have improved turn and narrowed our assortment while increasing our focus on proven constructions in more season less fashion items. We believe we are in a good inventory position for holiday and has minimal exposure to slow-moving or aged product.

We also saw significant benefits from the cost cutting and efficiency program that we have put in place over the past year. Our total SG&A expense was down over $7 million versus the comparable quarter last year. This was achieved despite expenses associated with 18 net new stores and investment in some key areas of our infrastructure including products designed and sourcing. As a result of our focus on inventory and expense management, we achieved earnings per share of $0.01 which was slightly better than expected.

Finally, we continued to have a strong balance sheet, ending the period with over $50 million in cash and no debt. As we discussed on the last call, we also converted our credit line to an asset based facility in the third quarter to provide us with up to $60 million of increased availability and strategic flexibility if needed.

I would also like to note given the recent headline news that we believe we have little to know direct exposure to CIT, we are continuing to move our business forward step-by-step, we have improved our products and reduced inventory levels, our margins are up and our costs are down. While we are mindful that the environment remains both challenging and uncertain, we are working to build on our momentum, and we believe that our fourth quarter results will show improved operating profitability.

As you know, Kenneth and I have partnered together in crystallizing the strategic vision for the company. Now I would like to give you a sense of the progress we are making on that plan. Two of our most important strategic initiatives are linked. Energize the brand and create compelling product. There is no clear example of how we have done this than the launch of our patented 9-2-5 footwear line this past quarter. Kenneth is spearheading this effort and working closely with our team to reinvent our business classification-by-classification.

You may remember that our last conference call was the day before our launch event at our Rockefeller Center store. The next morning there was a line of approximately 1,500 people out the door and around the block. Just prior to the event, Kenneth appeared on Good Morning America with an excellent feature piece on the comfort technology. And for those of you who missed this, you can see it on our website. By all accounts, this launch was a great success.

Since the launch in August, our consumer direct women’s footwear is up 15%, a 35-point swing versus where we were prior to the launch with 28% less inventory. We incorporated the revolutionary 9-2-5 comfort technology into very practical and still great looking shoes. This enabled us to sell through our first deliveries of the product at a very fast pace and at full margin.

We are moving forward with a broader assortment in our stores and are taking advantage of the exclusivity to capture increased retail and website traffic. We will also be doing an exclusive wholesale launch of 9-2-5 at selective top Nordstrom doors this spring in preparation for a wider wholesale rollout in the fall of next year.

With respect to our overall merchandise assortment, we are positioning our Kenneth Cole brands to be the modern wear to work day to night resource for contemporary men and women living the metropolitan lifestyle. We are building upon our strong footwear foundation and heritage to create head to toe look for a variety of wear occasions, including Day N Time, night out and weekend casual. This approach seems to be working as men’s and women’s apparel are now our fastest growing category.

In particular, we are continuing to see momentum in denim, two separate dresses and outer wear. We are also achieving better balance between fashion and core styles and we believe we are providing improved price value to our consumers by executing well at each level of our good, better, best pricing natures. This is important as avoiding promotion and markdown is an essential component to ensuring that the brand stays strong.

Consumers have become increasingly discerning in their purchases and we believe that our positioning as accessible designer fashion bodes well in this economic environment where versatile, season less items have increased, appeal and relevant.

We are also very proud of the work we have done in marketing over the last couple of season. Our campaigns are much more product and fashion focused than in the past while retaining our unique social voice. We believe they clearly depict our position as the quintessential metropolitan lifestyle brand for modern men and women who are as we say confident, clever and cool.

To best reach this sophisticated audience, we have employed a variety of new media strategies which includes Facebook, Twitter and an active blogger effort. Obviously, the work associated with revitalizing our brands and products is an ongoing process. The response to our new product lines in advertising is very encouraging.

We have products in many classifications selling at historically high sell through rate and we are now focusing on optimizing our merchandise mix and inventory allocation to capitalize on consumer demand.

We are also working with the team to improve our processes with the particular on building our test and react capabilities, increasing our speed to market and enhancing inventory fulfillment. Ongoing improvements in products and process are fundamental to driving better business performance.

Now let’s take a look at our retail and wholesale businesses. As you may recall, our third strategic initiative is to accelerate our retail development. In total, our consumer direct business had a mixed quarter. Growth from new stores which are performing well was offset by a 12.9% comps declined versus positive comps last year.

We have seen improvement in comps over the course of the last six weeks and expect this trend to continue throughout the fourth quarter particularly given easier comparison. Perhaps more important than the sales trends, our margins are strong. This is the result of better products, improved price value and an increased focus on customer service in the overall shopping experience.

Given this trend, we are confident in our ability to generate further operating profit improvement in the fourth quarter. We believe we have compelling items for both self purchased and kids giving to maximize this critical holiday season.

Our biggest issue in retail remains the profitability of our full-price fleet. As we have discussed on prior call, many of our stores are oversized and our rent as a percent of sales is too high.

We are pursuing a number of initiatives to optimize the fleet including store closures, right sizing and rent concession. We have successfully negotiated concessions with several landlords and we are grateful for their support. However in other instances, we will consider all options to improve our profitable.

Full-price retail is an important part of the future of our company and represents the face of the brand. Our stores enable us to showcase the Kenneth Cole lifestyle, consul the selling environment and make the necessary emotional connection with our consumers. We are making progress towards creating a viable economic model for our full-price stores.

I would like to note that our retail test stores continued to show superior results compared to the control group. Since the start of the test at the beginning of the second quarter, comp store sales and the test stores have run approximately 25 percentage points higher than our control group and gross margins has run approximately 4 percentage points higher. We will continue to evaluate and fine tune the test stores through the holiday season and determine how to move forward in 2010.

In terms of our other consumer direct business segments, we opened five Kenneth Cole outlet stores in the quarter. The new outlet stores opened in 2009 are generating sales per square foot about 10% higher than the balance of the change and double-digit four-wall contribution. We will consider opening new outlet locations opportunistically. I should also mention that our Internet business continues to grow with a 40% increase in sales during the third quarter.

Our fourth initiative is to evolve wholesale. In order to improve this business, we rationalize our portfolio and are reducing our distribution to off-price channels. Over 70% of the decline in wholesale was due to our plant closures of our unprofitable Tribeca and Bongo footwear lines, associated private label and the plant reduction in our off-price business. We will be smaller but healthier and more focused. This should increase profitability and positions us for growth.

Now in terms of our Q1 backlog, it is nearly 30 full percentage points better than our Q4 backlog. Excluding exited businesses, our Q1 backlog is only down 6%. This is the result of our focus on better balanced assortments, improved price value relationships and enhanced partnerships with our key department store customers. We believe that over the next couple of quarters, backlog will continue to improve.

In addition while wholesales are still down, we are seeing improvement in our gross margin rate and we think that the work we have done on the product is starting to take holds of consumers. We expect to see further year-over-year wholesale gross margin increases during the holiday and spring season.

Our fifth initiative is to go global. We have continued to support our international licensee base while also developing a direct international wholesale business. We are experiencing expressed impressive success with this wholesale direct model in the UK and plan to extend it with other key partners in 2010. We believe this profitable business model is a good way to expand the reach of our brand with minimal capital investment until the global environment improves.

We are also launching a new licensing deal in Turkey, a key European gateway to the Middle East and Eastern Europe. This agreement provides for five new stores in the territory adding to the 65 stores we already have outside the United States.

Finally, our last strategic initiative is to build the winning consumer driven culture. Kenneth’s visionary leadership has renewed our focus on product innovation and business creativity.

In addition, we have strengthened our management team in the third quarter with a new Creative Director, Chief Supply Chain Officer, and VP of our Internet Business. These individuals enhance our existing product and process capability and we are confident they will play a role in further improving our result.

I will reserve some additional comments for closing. But I would now like to turn call over to David to discuss our third quarter financial results in greater detail.

David Edelman

Thank you, Jill. Good afternoon. I will start with the income statement for the third quarter. Consolidated net revenues during the quarter were $103.8 million, a decline of 21.5% versus the year-ago level of $132.1 million. Wholesale sales during the quarter were $51.7 million versus the year-ago level of $77.6 million and represented nearly all of the year-over-year reduction in consolidated revenues.

As discussed, our revenue decline was anticipated and approximately 70% of that decline reflected our planned exit from our Tribeca and Bongo businesses as well as reductions in associated private label programs and in off-price distribution. Of course, the challenging market environment also has played a role.

Our consumer direct revenues in the third quarter were $41.7 million, down 2.2% versus the prior year’s quarter. Revenue associated with 18 net new stores opened since the close of the third quarter last year was offset by a comp store sales decline of 12.9%.

Licensing revenue during the third quarter was $10.4 million, a drop of 12.8% versus the prior year. About half of licensing declined was due to a reduction of licensing sales into the off-price channel.

Consolidated gross margin during the quarter increased by 220 basis points to 43.3% compared versus the year-ago level of 41.1%. This improvement was driven primarily by a strong performance within consumer direct for products improvement and much tighter inventory resulted in reduced markdowns. Additionally, the consumer direct division which operates at a higher gross profit percentage within the wholesale segment increased as a percentage of total revenue versus last year.

SG&A expenses in the quarter were $44.6 million down 14.1% versus the year-ago level prior period’s level of $51.9 million. This $7.3 million improvement was achieved despite an additional $2.4 million of expenses associated with operating 18 net new stores and shows the effectiveness of our cost cutting and operational and streamlining initiatives.

As a result of these factors, we generated an operating profit for the quarter of $286,000. Earnings per fully diluted share for the quarter were positive $0.01 versus the year-ago loss of $0.09 per share. This is slightly better than expectations primarily due to better gross margins. I would note that the year-ago period’s result was impacted by $0.18 per share of the impairment charges associated to the write-down of investment.

Turning to the balance sheet, cash at quarter’s end was $50 million. And we continued to have no long-term debt. In addition, during the quarter, we amended our credit facility to provide us of up to $60 million of availability. Also as Jill mentioned, we believe we no longer have direct exposure to CIT. As discussed, we have heightened our focus on inventory management.

Consolidated inventory at the close of the quarter was down $20.1 million to $36.4 million from $56.5 million at the end of the third quarter last year. This 35.5% improvement compares favorably to the revenues declined up 21.5%, reflecting faster inventory turns. We believe our inventory is current and right sized for our Q4 sales plan and should facilitate a further improvement in our gross margin.

With the respect to guidance, we believe that we will see continued improvement in our fourth quarter operating results. We expect that current improvement in comp store sales trend to continue due in part to easier comparisons and that the wholesale segments will remain under pressure until year end.

We expect licensing revenues to be down mid single digits. As a result, we are anticipating consolidated net revenues in the range of $107 million to $112 million. We anticipate several points of gross margin with last year due to our improved inventory position, better products and soft comparisons to the last year.

SG&A expenses will continue to trend lower on an absolute basis similar to Q3 due to the company’s streamlining initiative. As a result of these factors, we currently expect operating earnings per share in the range of $0.04 to $0.08 with the year-over-year improvement driven by a combination of better gross margin and improvement in the consumer direct comp store sales and a continued benefit of our cost reduction activities.

I would now like to turn the call back to Jill for some closing comments.

Jill Granoff

Thank you, David. I will conclude by saying that we are seeing some tangible results from the implementation of our strategic plan. Let me recap what we have accomplished since our last call. We have taken important steps to regain our footwear leadership position with the launch of 9-2-5. Comps are stabilizing and our backlog is improving. We have reduced our inventory levels and accelerated our turn. And we have improved our margins and lowered our cost.

With continued focus on improving our products and our processes along with the ongoing commitment of our talented teams, we are confident that we will realize the growth and profit potential of our brands and business.

Thank you. We are now ready to take your question.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of Mr. Scott Krasik with CL King. Please proceed.

Scott Krasik – CL King

Hi, everybody.

Jill Granoff

Hi, Scott.

Scott Krasik – CL King

Good job on improving the controllables here. The first question I have, I just want to dig into that backlog. It’s good to see that the backlog is looking a lot better for next year, Jill. It doesn’t seem like some of the new stuff is really going to move the needle. So maybe talk about the improvement or the better less negative trends that you are seeing in some of your core Reaction either men’s or women’s, where is that coming from?

Jill Granoff

The improvement in Q1 backlog is really coming in footwear. We have focused on our footwear heritage and we have also focused on our core brand. And so that’s Reaction and Kenneth Cole New York for men. And as you may recall, we did pullout of Kenneth Cole New York ladies from our wholesale distribution.

And our initial plans were to re-launch that in the fall of next year, but because our partnership with Nordstrom is so important and they are such a great footwear resource and they were so excited about this we were able to basically launch in a few selected doors in Q1. Bu the big pickup that you are seeing is really in footwear, really in Reaction ladies and then Reaction and Kenneth Cole New York men.

Scott Krasik – CL King

And do you feel good going – Reaction sort of had a comfort story over the last couple of years, I mean is that going to continue even though the kind of the 9-2-5 has that element as well?

Jill Granoff

Yes. In this economic environment, we think comfort is really important. And our focus is on marrying comfort and fashion. So, yes, Reaction will continue to have a comfort positioning as well. And as you may know, especially in Reaction ladies, we have a very strong spring business with our open toe construction, we have a strong spring season in ’09 and we are looking to really build upon that in spring of ’010.

And on the men’s side, we have really designed into some key price points to improve price value and we have some expanded distribution as a result of that. And we are very pleased also to see a number of our styles go on to replenishment, so all of these things are helping improve our backlog.

Scott Krasik – CL King

That sounds good. Then, just in retail, do you – if you said, I missed it. Did you say what the comps had improved during the last few weeks, are they close to positive or –?

Jill Granoff

We did not say, but we are really seeing week-over-week improvement. And even looking at Q3, while we may not be happy with the 12.9% if you were to look at July, August, September, every month we are seeing improvements. And a lot of it is driven by 9-2-5, it’s certainly helping. And I think it’s important to note that this was just launched in August. It was on presale, really the inventory hit the stores in October, and we are seeing a great swing in footwear, women’s footwear specifically.

Before we launched 9-2-5, our footwear sales – our ladies footwear sales were down double digit. We have seen a 35-point swing in our footwear comp as a result of 9-2-5. And that’s on 28% less inventory and very healthy margins. So, we think the comps will be planned flattish and hopefully we will able to exceed that.

Scott Krasik – CL King

Yes, that’s good. And then just a couple more little ones, you said that you are not – you are going to open more outlets next year or –?

Jill Granoff

What we said is that we will consider opening outlets opportunistically. The key is getting the right location in the right center in the right sized box. We are pleased with our outlet performance. They generate cash, we have double-digit four-wall margins, they hit our ROI hurdles. But the key is really getting the right locations in the right centers and we will evaluate each opportunity as they arise.

Scott Krasik – CL King

Okay. But just in general, I mean, you are no way near sort of saturation by relative towards some outlets.

Jill Granoff

No, not at all. I think, Scott, what we have mentioned in our initial strategic plan which does remain intact is that there are roughly 200 outlet centers and we believe that 100 of those outlets are premier centers that we would open stores in. I think today David can give the exact number, but we have roughly 65 outlet stores, so we certainly see a room to open additional outlets to reach that 100 store target over the next few years.

Scott Krasik – CL King

Right. David, what is the current outlet count and full store count?

David Edelman

Well, we have 40 full-price stores and 66 outlets. There is actually two outlets on scheduled to open in the balance of 2009.

Scott Krasik – CL King

And any closures?

David Edelman

Not in the fourth quarter.

Scott Krasik – CL King

Okay. And then, just – David, just so I know for modeling purposes, I mean $0.01 versus $0.09 loss is some sort of a GAAP number. So for going forward, is that $0.04 to $0.08 versus the $0.67 loss a year ago or the $0.27 that you reported sort of an adjusted basis that we had previously been using?

David Edelman

If you take out those one-time charges, the $0.04 to $0.08 is versus the loss of $0.27 last year. There was $0.40 last year of impairment charges.

Scott Krasik – CL King

Okay. So then, just to be consistent, because – so I – try and let’s keep using adjusted within this quarter actually if I take out that $0.03 impairment from your investment, will it be $0.03 this quarter, because it’s $0.09 positive last year in the third quarter excluded the impairment from your investment.

David Edelman

Last year’s number had a $0.18 impairment charge. That would have been a positive $0.09. And this year we had $0.01 in the investment write-downs relating to the balance of the auction rate securities we have.

Scott Krasik – CL King

Okay. So, just – so $0.01 that will be like $0.02 this quarter.

David Edelman

Yes.

Scott Krasik – CL King

Okay. Thanks.

Operator

And the next question comes from the line of Jeff Van Sinderen with B. Riley. Please proceed.

Jeff Van Sinderen – B. Riley

I wonder if you guys can give us more detail on the operating metrics, what you are seeing in your full-price stores and then what you are seeing in your outlet stores in terms of the transaction account, UPT, AUR, things of that nature.

David Edelman

So, what we are seeing is that – most of the early part of the outlet businesses were well out performing our full-price stores, Jeff. And we don’t break it out, we reported consolidated segment information. We are seeing now and some of it’s driven by the success with 9-2-5 is that the full-price stores are starting to show an improvement in all metrics. Our UPTs were kind of flat year-over-year. Our AURs are down a little bit. Our traffic is down quite a bit and that’s what’s partially leading to the negative comps.

Jeff Van Sinderen – B. Riley

Okay, got it. And then maybe you can talk a little bit more about product initiatives that we should see coming to fruition next year. Obviously 9-2-5 is a big thing, and maybe you can also talk about how you are broadening the 9-2-5 line?

Jill Granoff

Sure. There are a number of product initiatives underway and really a lot it builds upon 9-2-5. We launched 9-2-5 with five core styles we call it Silver Technology, because they all have that fabulous silver heel. We are now rolling out a much broader assortment. And actually you can see that in our stores now and we will continue to build upon that for the spring season. So we will extend 9-2-5 beyond the core style.

In addition, we are looking at how do we take that 9-2-5 positioning and potentially extend that into other classification, be that men’s footwear, it could also include handbags. So there are a number of things underway. But obviously we don’t want to reveal any of our secrets before they are launched. But certainly we are focusing on that. The other thing that’s been very successful for us is as I mentioned is our position that’s kind of that modern wear-to-work resource.

And we have seen as I mentioned great success in things like suit separates and our dresses, things that you can wear to work, but you can wear it out at night, you can wear things on the weekend, so you will see a lot more focus on head-to-toe look. And certainly again building up of 9-2-5 is a great pump that women can wear, how do you now complete the look. And so you will see I think increased emphasis on footwear and apparel as the key drivers moving forward.

Jeff Van Sinderen – B. Riley

Okay. And I know you mentioned your apparel business as one of the areas of growth. I think you said that was your fastest growing business. So just – since you just sort of touched on that, maybe you can give us more flavor in terms of is it just the women’s business where you are doing suits and separates or are there other things happening in the men’s business as well? Just any more flavor you can give us on the apparel business.

Jill Granoff

Sure. Well, I think the key thing is, in the third quarter, they were our fastest growing business. In the fourth quarter, women’s footwear we believe will be among the fastest growing as well, again remembering that we didn’t really get full inventory to store against 9-2-5 until roughly the early October timeframe. The suit separates by the way are in men.

And so what we are seeing in men’s is really great momentum in denim, graphic tees, long-sleeve woven and suit separates. And what’s interesting is that we are traction in wholesale in our department store doors as well as in our own retail stores. And then on the women side as I have mentioned, dresses are doing quite well and outerwear is also doing quite well. And so those are some of the key categories that we are pleased with the results in.

Jeff Van Sinderen – B. Riley

Okay. Good. And then my last question, obviously, you guys are trying to address the real estate issue and your full-price retail store. I was just wondering where you feel like you are out in the process now? How much more can you do to impact your real estate situation?

Jill Granoff

We are in active discussions with all of our landlords. And we are pleased with some of the results that we have achieved. As I mentioned, we have seen some significant renting sessions. We have seen switchovers to percentage deal. We are pleased with the reductions.

Unfortunately, we have to amortize them over the life of the lease, so if this certainly helps us from a cash perspective, we don’t see the full impact from a P&L perspective. But we are in very active discussions with many of our landlords with regards to either concession, downsizing and in some cases even store closing.

Jeff Van Sinderen – B. Riley

Okay. Good to hear. Thanks very much and good luck this quarter.

Jill Granoff

Thanks.

Operator

And the next question comes from the line of Mr. Sam Poser with Sterne Agee. Please proceed.

Sam Poser – Sterne Agee

Good afternoon. The – just specific on real estate, the Rockefeller Center store has been a conversation for quite some time, has there been progress made some specifically on that location?

Jill Granoff

As we have mentioned Sam in the past, we are continuing to market the space very aggressively and we have been in active dialog with Tishman as well and some prospective tenant. And we are looking forward to sharing concrete information with you once it’s available. Right now our focus is really on optimizing holiday. And as soon as we have more information to share on Rock Center, we will be sure to communicate that to the investment community.

Sam Poser – Sterne Agee

Thank you. And the 9-2-5 shoes which did get a – clearly got a very good response at a price I guess of $165 to $198 I believe that’s in that range depending on the shoe. The margin structure of that product was suited for the wholesale – I mean through your retail channels, what kind of changes of the product are you going to have to make to allow the margin structure to work properly as you roll it out to wholesale.

Jill Granoff

We do have very good margins on 9-2-5. The price points actually range on to about $135 for a fashion flat or a flat with an ornament, the core pump is at $160. We also have booties at $195. And you will see some products actually in the spring season that actually cross the $200, because those are the peak of the pyramid items in terms of aspiration.

We are really not anticipating making a lot of changes to shoe. We believe that this provides great value to the customer. We don’t anticipate a lot of markdowns. So we are not making changes to the shoe in order to sell into wholesale, but we will certainly look at doing some other things possibly even extended sizes, et cetera to really help us with the sell through rates and to reduce the markdowns.

Sam Poser – Sterne Agee

But in wholesale, will your initial – will your – the margin, I am not even thinking about markdowns, so but will your gross margin on wholesale given you are selling it directly and benefiting it from the double margin at this time. Are the shoes built to withstand the middleman so to speak?

Jill Granoff

Yes.

Sam Poser – Sterne Agee

Okay. And then you discussed improvement and speed to market, more fulfillment and building more of a test and react program. Could you give us some details as to where you are in those three initiatives?

Jill Granoff

Sure. In terms of inventory fulfillment, one of the things that we have done which is certainly help us meet consumer demand is we are no longer just shipping in case pack, we are actually fulfilling in terms of open stock. So that is really helping us in terms of size optimization. And in addition to that, we have put in place a store lookup program, so that its inventory should exist at another store. We can sure be to meet customer demand.

And the third thing that we have done is we have established a program on – called hot pursuit with GSI, looking at that as a warehouse as well. So we are not just looking at the individual store as the only place to fulfill demand, but we are looking across the fleet as well as our warehouses and also our Internet provider to fulfill the demand.

In addition to that – I will turn it over to David in a minute who can talk to you about the fact that we have actually cut out some cycle time in delivering products to store much faster, all of those things which help meet demand.

And in terms of test and react, we have had some great success in that in apparel as well as in handbag and we are working on that in footwear too. And in terms of speed to market, as you know, Peter Charles just joined us as our new Chief Supply Chain Officer from Nine West.

And this is a key focus area for him, because we know the closer into market we are, the better off we will be. And what we are doing is really charting out timetables to market by each product category and then opportunities to really streamline, decision-making, sampling, et cetera, so that we can get our products to market sooner.

David, do you want to talk a little bit about what we have done on the distribution side?

David Edelman

Yes, we have put something in place at the beginning of October is really just an enhancement to our replenishment program. So what we have done is we have a focus to bring down our store inventory, then increase our inventory turns. And I think you can see from our results, our inventories are way down. And what we are doing is we are replenishing in faster to the stores with our replenishment program.

We have eliminated some of the steps at the consolidator, we are going store direct now from our factories and we are able to fill into the stores on our open stock program. This is much quicker than we have put in the past. So we are hoping that program allows us to stay in stock with product and also speed up our inventory turns.

Sam Poser – Sterne Agee

Thank you very much. Good luck.

Jill Granoff

Thanks, Sam.

Operator

And the next question comes from the line of Janet Kloppenburg with JJK Research. Please proceed.

Janet Kloppenburg – JJK Research

Everybody, how are you?

Jill Granoff

Good. How are you Janet?

Janet Kloppenburg – JJK Research

Good, good. Nice quarter. Nice improvement. I was just wondering if you could talk about the longer plans for the – longer-term plans for the 9-2-5? I know I think you are just selling it in the direct channel, I think it’s just women’s. Have you announced product extensions, will you go to men’s, will you sale it wholesale, et cetera?

Jill Granoff

We have not announced product extensions yet. But you can be assured that we are working on them.

Janet Kloppenburg – JJK Research

Right.

Jill Granoff

We truly believe that 9-2-5 can be our single largest product category, especially when we roll it out to wholesale, as well as international, there has been a lot of interest on the international front.

In terms of our plants for wholesale, as I had mentioned – before we had plans on keeping it exclusive through fall of ’010, but to reinforce our relationship with Nordstrom and because of their dominant position, we decided to alter our plans and allow top doors to market the product. So you will see selective top door distribution in Nordstrom this spring.

And then, with regards to fall look, we got a hot product here, and our goal is to keep it hot. And we have to ensure full margin sell through. So I think once we see the result throughout the holiday season, early reads on spring selling and our partnership with Nordstrom, we will then finalize our fall plans.

Janet Kloppenburg – JJK Research

Okay. So – but I am just – I guess what I am thinking is it’s November and you have to present a line if you are going to market it in the fall, so there is not that much time left. Is there if you to make that decision?

Jill Granoff

Yes, there is.

Janet Kloppenburg – JJK Research

There is, okay.

Jill Granoff

Yes.

Janet Kloppenburg – JJK Research

So, it is still a possibility that it could boost back half ’10, fiscal ’10.

Jill Granoff

Absolutely. I mean, we are talking now as I said with Nordstrom on really finalizing the initial orders and the spring plan, so it’s November and we are talking to spring. And certainly when we get to the February time frame and fanny, et cetera, that’s when we all really look at what the back half can be.

Janet Kloppenburg – JJK Research

Okay. And then, my other question is just on the outlook for wholesale improvement, once if you ex-out David the discontinued businesses, can you talk a little bit about the outlook what the trends in the wholesale business, are they – do you think that that business can start to grow in the next couple of quarters?

David Edelman

Really, we aren’t prepared to talk about 2010 guidance, yet. But we do think that the business will grow and we will be anniversarying those exited businesses through out the first three quarters of 2010.

Janet Kloppenburg – JJK Research

Okay. But then, as far as the go-forward, I know you don’t want to talk about it, but it sounds to me like we should be thinking more about margin improvement, the kind of margin improvement if not more that you have displayed here in this quarter and that you will fuel in on the opportunities for top line growth as we move throughout fiscal ’10?

David Edelman

Yes, I think.

Jill Granoff

Absolutely.

David Edelman

We are absolutely looking for gross margin improvement. And I think as we mentioned, even in Q4, we are looking at several points of gross margin.

Janet Kloppenburg – JJK Research

Right. No, no, I know you said that. But, as we go forward, it sounds to me like that’s how you want us to be thinking about the restoration of margins and the business. I think in other words, the margins will keep growing and then later on, you might start fueling the top line.

David Edelman

I think that’s a good outlook.

Janet Kloppenburg – JJK Research

Okay. Thanks very much, and lots of luck.

Jill Granoff

Thank you.

Operator

And the next question comes from the line of Mark Cooper with Wells Capital. Please proceed.

Mark Cooper – Wells Capital

Good afternoon. Thanks for taking the call. Just unclear, last year December and March, your gross margins were in the high 30s and the low 30s, is that right?

David Edelman

Last year’s fourth quarter?

Mark Cooper – Wells Capital

Fourth quarter and first quarter this year.

David Edelman

Last year’s fourth quarter was 39.7%. And –

Jill Granoff

It was also in the first quarter in the 30s.

David Edelman

Yes, we have been lower; we’re at about 35% – 33.9%.

Mark Cooper – Wells Capital

And then, can you tell us what your cash flow is and the CapEx number was for the quarter? I know you’ve put that in your – and as well as the segment income, I know you’ve put that in your Q, but do you have that available?

David Edelman

Yes, we did about $3.3 million in CapEx. And we are running on – for an annual rate, we are expecting to be around $11 million.

Mark Cooper – Wells Capital

And the cash flow from operations in the quarter or cash used rather?

David Edelman

Cash used, we were at $40 million – $57 million last – at the end of June. We ended this quarter at $50 million. We hit a high and low usually Q1 and Q3. We are expecting year-end cash balance to be around $60 million plus.

Mark Cooper – Wells Capital

Okay. And then, the wholesale and the consumer segment income that you’ve put in your 10-Q, do you have those numbers?

David Edelman

No, we haven’t filed the Q. We are going to file that probably next Monday.

Mark Cooper – Wells Capital

Do you have the numbers though?

David Edelman

No, we are still finishing up with the accounts and the filings.

Mark Cooper – Wells Capital

Okay. In the – when you talked about the profitability of the stores, is it the – what sort of baseline revenues do you have to have in those stores on the full-size stores or the full-price stores rather. What kind of revenue base per store do you have to have to make those things profitable? I don’t – as far as I can tell you, you have only made on the stores in one or two quarters in the last several years, is that accurate?

Jill Granoff

Well, we did have positive comps in Q3 last year as I mentioned. And we have had –

Mark Cooper – Wells Capital

I am talking – I am not actual money not the sales, but –

Jill Granoff

So, on the bottom line? Yes, one of the issues is a lot of our stores as we said are oversized. And as a result our productivity per square foot is low. Right now we are about $100 away in terms of productivity per square foot of where we want to be to drive double-digit four-wall profit. And we will get that by a combination of driving increased productivity again by about $100 per square foot as well as improved margins, and then also reducing our SG&A expenses, the two variables there are payroll and rent as you know. And so we will see improvement in both of those to drive improved profitability.

Mark Cooper – Wells Capital

Well, and I appreciate you putting the real number around that. You no doubt have whacked the SG&A and things looks like they are going well, so thank you for that.

Jill Granoff

Yes, I mean the other thing is that you know and just in case you are wondering how we plan to drive the sales improvements, a big focus for us is driving conversion. So even if small traffic is down, we think we have an opportunity to drive improved top line sales by increasing conversion of the customers that come to our store.

We are currently in the low teens based on my prior experience working with a number of vertical retailers, we think that number should be in the mid-to-high teens or actually doing a study now to understand conversion better, we think a big piece of it is size optimization.

But, we think by focusing on conversion, and if we can get two or three points of increase, that could be a significant improvement in our top line, which could then drive the improvements in productivity per square foot and obviously some profit flow through as we leverage the fixed expense base.

Mark Cooper – Wells Capital

Well that’s the math. I think you got your work cut out for you on those full-price doors. But the – I have just lost my change of thought. The operating earnings number that you sight that you are expecting for the fourth quarter, am I clear that that’s everything that should be operating income, does that include any income from the balance sheet at all income, interest income rather?

David Edelman

Right now, we are projecting less than a $100,000 of interest income in the fourth quarter.

Mark Cooper – Wells Capital

Okay, all right. Great. Well, thank you for your time.

Jill Granoff

Thank you.

Operator

And the next question comes from the line of David Berman with Berman Capital. Please proceed.

David Berman – Berman Capital

Hi, guys.

Jill Granoff

Hi, David.

David Berman – Berman Capital

I was just hoping you could spend a little bit more time focusing on inventories and how you reduced them which was impressive, and how much further do you think you can? I mean right now, for example, you have improved them a quite a lot. I mean you are down – last year’s to 56 days from 65 last year. I don’t know you are best compare yourself to, but if you get that down to 40, 45 days. And how you’re going about a little bit more detail? I know you mentioned earlier a little bit about the replenishment systems, but obviously this is one of the key areas that would improve your business?

Jill Granoff

Yes. So, let me tell you some of the things we are doing, and then I will let David add on. One of the biggest things we have done is we have narrowed our assortment and we have increased steps per skew, so we are comfortable with the inventory levels.

In some cases, we felt that we were over assorted. I mean if you think about men’s, women’s, apparel, accessory, footwear, we really said, you know what, what are the core constructions, the proven constructions and how do we build upon that. We have also looked at the fashion core mix.

And as we have talked about on prior cores – prior calls we were just way too extorted in the fashion vein. So a big part of the reduction was really just pretty basic merchandise planning, looking at the balance between fashion and core, narrowing the assortment, both across and within categories, but at the same time increasing depth per skew to meet demand. So we are pretty comfortable with the inventory level.

David Berman – Berman Capital

All right.

Jill Granoff

In general, we prefer to chase sales and leave a little bit of money on the table versus having too much inventory. We do think there is a bit of further opportunity in the future and that will come by improving turn as we gained traction with our speed to market initiatives. David, you want to add anything?

David Edelman

No, I think you hit it. We looked at model stock levels and we tried to bring the inventories down to increase turns. I don’t think we are going to have to – we are going to level off and we are going to strive to make sure that our inventory levels are decreasing or increasing in line with our sales demand. I think that’s more of the goal to just knock it down like we have been whacking it for the last couple of quarters.

David Berman – Berman Capital

Well, I mean your sales are down 21 and your inventories are down 36 which is a good relationship, but you can probably bring the 56 days down further which would imply that you have to keep them bringing down to more than sales are done.

Jill Granoff

I think the key is that we are looking to improve our turns, so inventory is down, we still think there is opportunity to improve turns further, and we have actually just set turn targets by category and by channel. And we will really monitor our business to ensure we hit those turn levels. We think that –

David Berman – Berman Capital

Do you have actual sort of targets in your strategic plan, a specific number you can share with us that you are targeting for either number of days or the number of the turns you can kind of go both ways compared to – because I am sure you have looked at it compared to your peers.

Jill Granoff

Yes, we don’t really share that. But we are focused on it.

David Berman – Berman Capital

Okay, well much improvement. Thank you very much.

Jill Granoff

Thank you, David.

Operator

And we have a follow-up question from the line of Mr. Sam Poser with Sterne Agee. Please proceed.

Sam Poser – Sterne Agee

Yes, I just wanted to – I wanted to follow up, do you – when did you run your – do you run your own website now or is it being run by GSI?

Jill Granoff

It’s being run by GSI.

Sam Poser – Sterne Agee

So who owns the inventory at the website?

David Edelman

We do.

Sam Poser – Sterne Agee

So – and I am – and you are not going to like this question. Given the strength of the silver business, I am on the website right now, and over the 35 SKUs of the silver product in women’s on the website, 26 of them today at this moment are at 40% off. Given the strength of that product, why would that be?

Jill Granoff

Okay. Well that’s a good question. And that’s because today is Election Day. And last year we had a very big promotion on Election Day. It was a 44% off for I guess the 44th President and a President to be proud of, so we were really celebrating last year, everyone was off, everyone was voting, and so we have a one-day only promotion, it’s only today.

If you go on tomorrow, it will be off tomorrow. And basically we are saying that we elect you to be friends and family and we are inviting everyone to take advantage of our associate discount, but this was a one-day thing to really anniversary the huge results that we achieved last year on Election Day.

Sam Poser – Sterne Agee

And does that – is that included at the retail stores as well?

Jill Granoff

Yes, one day at our stores in recognition of Election Day. Again, we are electing our consumers to be a friends and family member and take advantage of the discount for one day.

Sam Poser – Sterne Agee

Well, that was easy clarification. Thank you very much.

Operator

Ladies and gentlemen, this concludes the question-and-answer session for today’s call. I would now like to turn the call over to management for any closing remarks.

Jill Granoff

We thank you again. Kenneth and I would like to thank everyone in the organization for the hard work and dedication that they have been showing us. And we would also like to thank our customers, our suppliers, and our shareholders for their continued loyalty and support. Thank you again.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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Source: Kenneth Cole Productions, Inc. Q3 2009 Earnings Call Transcript
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