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Executives

William L. McComb – Chief Executive Officer, Director

Andrew C. Warren – Chief Financial Officer

Tom Fitzgerald – Senior Vice President, Direct Brands

David McTague – Executive Vice President, Partnered Brands

Analysts

Benjamin Rowbotham – Goldman Sachs

Robert S. Drbul – Barclays Capital

Omar Saad – Credit Suisse

Mary Gilbert – Imperial Capital

Jennifer Black – Jennifer Black and Associates

Chi Lee – Morgan Stanley

Jim Chartier - Monness, Crespi, Hardt & Company

Liz Claiborne Inc. (LIZ) Q3 2009 Earnings Call November 4, 2009 10:00 AM ET

Operator

Welcome to the Liz Claiborne Third Quarter 2009 Conference Call hosted by Chief Executive Officer, Bill McComb. After the opening remarks we will be taking questions. This call is being recorded and is copyrighted material. Therefore, please note that it cannot be recorded, transcribed or re-broadcasted without Liz Claiborne's permission. Your participation implies compliance with these requirements. If you do not agree simply drop off the line.

Please note that there will be a slide presentation accompanying the prepared remarks. The slides and earnings release can be accessed at www.lizclaiborneinc.com in the Investor Relations section. There are separate links to the slides for the Webcast and phone participants.

Please note that the statements made during this call that relate to the company's future performance and future events are forward-looking statements within the Private Securities Litigation Reform Act. These forward-looking statements are based on current expectations, and are subject to the qualifications set out in this morning's press release, as well as in the company's 2008 annual report on Form 10-K and quarterly report on Form 10-Q for the third quarter of 2009, under the captions Item 1a Risk Factors and statement regarding forward-looking statements as filed with the SEC.

Also, please note that during this call and in the accompanying slides and press release, net sales, gross profit, gross margin, SG&A, SG&A as a percentage of sales, operating income, operating margin, income or loss from continuing operations and EPS are presented on both a GAAP and a non-GAAP basis. Reconciliations of adjusted results to the actual results are available in the tables attached to the earnings release and slides captioned Reconciliation of Non-GAAP Financial Information.

The company believes that the adjusted results for the third quarter and first nine months of 2009 and 2008 represent a more meaningful presentation of its historical operations and financial performance, since they provide period-to-period comparisons that are consistent and more easily understood.

Now, I would like to turn the call over to your host, Mr. McComb. Please go ahead, sir.

William L. McComb

Good morning everyone and thank you for joining our conference call to review our earnings results from the third quarter. Andy Warren, our CFO, is also here with me and will speak to the performance. For those of you that are using the speaker support slides that Paula mentioned, let's begin now on page two of that presentation.

Overall, we're feeling increasingly optimistic now with growing tracking in many important areas of our turnaround. While we're still losing money, the sales trend and net operating loss were in line with our internal forecasts and are moving in the right direction relative to second quarter.

We saw a positive break from the comp trends we have been seeing throughout the past three quarters. We've achieved significant productivity in our cost-out initiatives. We continue to post impressive results in cash generation and our balance sheet is strengthening.

In addition, we announced this morning that we amended our bank deal on Monday supporting a strong liquidity position throughout the term of this ABL. In addition, we say the arrival of a very strong and proven management team in Mexx in Europe, and we announced in the last month a new model in partnering with JCPenney for the Liz Claiborne brand that will make an important profit swing in the domestic wholesale business beginning next year.

All good, all important steps in the right direction; and as you'll see later, we're now seeing positive retail comps on Juicy, Lucky and Kate Spade.

On page three, you'll see how these results stack up against the operating assumptions that we previewed back in August. Our U.S. retail comps during the quarter were down minus 3% to minus 16% versus an assumption still of minus 15% to minus 25%.

Adjusted SG&A costs were down $63 million or 14% versus third quarter 2008. The quarterly adjusted operating loss is $33 million versus the $45 million loss in second quarter. Gross margin was not favorable.

Where we had planned to see gross margin flat to second quarter, we saw a 220 basis point reduction stemming largely from the Mexx business and secondarily from partnered brands. We will discuss that in greater depth in a few minutes, both Andy and I, in our comments that will follow.

Balance sheet progress was significant with inventory down 25%, accounts receivable down 24% and total debt reduced $145 million. And finally we ended the quarter with significant availability on the ABL of $203 million.

As I said, we see a lot of progress here on many fronts. Now Andy Warren will dive a little deeper into each of these areas. Andy?

Andrew C. Warren

Thank you, Bill, and good morning everyone. As you just heard from Bill, our third quarter financial results were very much in line with our expectations except for gross margin, which I will walk you through later in the presentation.

Also it is important to note that the recently announced JCPenney and QVC deals, as well as our newly installed Mexx leadership team, has had no impact yet on these third quarter results. You will see how we expect these two significant catalysts to drive meaningful, positive financial improvements in 2010.

Now let me walk you through the adjusted income statement on slide four. Sales from continuing operations decreased 24% versus third quarter of 2008. Partner brands and Mexx Europe accounted for almost the entire decline.

Gross margins decreased by 460 basis points. The next slide details this decline by segment. SG&A was down 14% versus 3Q '08. I'll later walk you through more details on our continued successful cost reduction efforts.

Operating loss was $33 million, which was $12 million better than our second quarter loss of $45 million. Importantly, this sequential improvement in operating performance should continue going forward.

Operating margin decreased year-over-year to a negative 4.3%. Although SG&A was down 14%, the significant sales and gross margin decline, mainly in Mexx Europe and partner brands drove this negative operating margin.

Lastly, adjusted diluted EPS from continuing operations was a loss per share of $0.43 compared to earnings of $0.39 in the third quarter of last year. This EPS result was generally consistent with our internal expectations, when you exclude the non-cash charge of $0.06 per share resulting from the impact of changes in foreign currency exchange rates related to the Eurobond.

As you may recall from the last conference call, after we wrote off all the Mexx goodwill at year-end 2008, the carrying value of our Mexx assets, which were a nature hedge for the Eurobond was now less than the carrying value of the euro bond obligation.

Therefore, a portion of the quarterly foreign exchange translation adjustment of the Eurobond is recorded to the P&L, all of it through equity. Again, all of this effect is non-cash. Moving now to slide five, as you can see we have broken out our third quarter gross margin decline by segments.

International-based direct brands, or Mexx business, had gross margins down 980 basis points versus last year and accounted for 54% of the total company gross margin decline. Higher discount and give-back rates as well as improvements in product quality to enhance the price value offering drove this dramatic decline in margins.

Partner brands gross margin was down 540 basis points and accounted for 40% of our total company decline. The majority of this decline was attributable to the underperformance of the Liz Claiborne and Claiborne brands.

The good news is that the recently announced JCPenney and QVC deals will reverse this negative margin trend in 2010. One of the most important aspects of the JCPenney and QVC deals is that we will no longer be subjected to the financial volatility of upfront discounts, end-of-season markdowns and returns. Now we are totally aligned with JCPenney via the gross profit sharing model and with QVC via the net sales licensing fee model.

Lastly, domestic-based direct brands, Juicy, Lucky and Kate Spade combined had a very healthy gross margin of over 54%. Although this is down nominally year-over-year, we are comparing two very different retail environments, with 3Q '08 being relatively robust compared to the much more promotional 3Q '09.

We continue to be highly focused on improving our total company gross margins across all of our segments, through more focused merchandising strategies and through sourcing disciplines, as well as our Li & Fung partnership and, therefore, expect to realize approximately 200 basis points of improvement in the upcoming fourth quarter versus this third quarter result.

Slide six: We successfully re-engineered all of our cost structures in recognition of our declining top line. We have been attacking the cost line in all of our segments. Later in the presentation, I will outline a total adjusted SG&A forecast for 2009 and additional cost actions we have taken this year in order to properly re-baseline our total SG&A structures for 2010. Looking first throughout the current quarter, our year-over-year third quarter SG&A trend reflects our successful cost productivity efforts with SG&A down fully 14%.

We have significantly reduced costs in our partner brands, international base drug-brand segments and have dramatically decreased our corporate overhead. Cost production initiatives in these three areas achieved $58 million in savings within the quarter alone versus last year. Conversely we redeployed a net $2 million into retail expansion and retail infrastructure.

As we have continually demonstrated, we are intensely focused on rightsizing our infrastructure and adding costs only where it makes sense, with fast payback and attractive returns. We will continue to reprioritize and challenge our cost base and our business models throughout the remainder of 2009 and next year, as we are more focused than ever on controlling the controllables.

Now to slide seven, we remain pleased with the results of our working capital management especially given our challenge earnings profile. Accounts receivables were down 24%, reflecting on one hand sales decreases in our International-Based Direct Brands and Partnered Brands segments, and on the other hand our intense focus on keeping aged receivables low.

We ended 3Q09 with inventories down 25%. Total debt at the end of 3Q09 was $829 million, down $145 million from the third quarter of 2008. Cash flow from continuing operations over the last 12 months was $336 million.

Despite the tough environment and our negative third quarter earnings, we still generated an enormous amount of cash flow. This strong cash flow includes $137 million of total net tax refunds throughout this past year as well as the $75 million associated with the Li & Fung sourcing agreement.

Capital expenditures were $108 million for the last 12 months. Most of this capital spent is dedicated to the net addition of 40 specialty and outlet stores across Juicy, Lucky and Kate, of which only 11 were opened so far this year.

Given the tough operating environment, we have planned our 2009 capital expenditures at approximately $75 million versus $194 million last year. Our current forecast of approximately $75 million is slightly higher than the estimated $70 million we previously communicated.

We were presented with several attractive brand-right opportunities, which drove our CapEx span at slightly higher. These investments were carefully vetted and we believe will contribute to future sales growth and profits.

Our next slide is titled 3Q09 Inventories. We continue to aggressively reduce inventory levels with international-based and domestic-based direct brand inventories, down 16% and 23% respectively, reflecting reduced inflows and approved management of excess liquidation during the quarter.

Partnered Brand inventories were down 36% in the quarter, as they also manage inflows and reduced ongoing levels. These inventory levels will continue to decline over the next year as we liquidate current Liz wholesale inventories and migrate to the new JCPenny and QVC models.

Across all of our brands, we're heading into holiday 2009 with cleaner inventories than prior years and dramatically reduced stock levels. Moving now to slide nine, we reduced total debt by $145 million for the third quarter of last year to $829 million. You have heard us say on several earnings calls and investor conferences, over this past year that one of our critical financial priorities is to deleverage the company.

As you can see, the strengthening of the Euro versus last year added $27 million to our total debt balance. We are highly focused on paying down debt and plan to continue this trend throughout the remainder of this year and next. We will utilize 100% of our free cash flow to reduce debt and plan no-share repurchases or acquisitions in the near or medium term.

I walked you through our availability calculation on prior conference calls, so today on page 10 I'll simply update you on the numbers. At the end of 3Q our availability was $203 million. Our actions are focused on keeping that availability high enough to meet our needs in any economic or operating scenario. Based on our current forecast, we are very comfortable with the forward-looking availability forecast.

On slide 11, we summarize a very important amendment we have successfully completed to our revolving credit facility. First and foremost, the amendment makes the fixed charge coverage covenant a permanent screening covenant for the remaining life of the facility, subject to the same minimum availability requirements that were previously in place.

The covenant no longer becomes a full-time maintenance test in July of 2010. To put this in context, at the end of 3Q09, our total ABR availability was $203 million and the minimum springing covenant threshold was $75 million. So our cushion was fully $128 million. Based upon our current forecast, we anticipate having sufficient availability to avoid springing the fixed charge coverage covenant.

The amendment also provides the necessary consents relating to the licensing agreement with JCPenny, where Penny has the option to purchase the marks in the U.S. and Puerto Rico at the end of the years five and 10 and other limited circumstances such as change in control.

On the second quarter conference call in August, we walked through the extensive cost savings we realized since 2007, our forecast for 2009 and our initial planning for 2010. Given the recent JCPenny and QVC deals as well as our better cost run-rates, we are summarizing on Slide 12 our updated adjusted SG&A forecast for the remainder of this year and next.

As you can see from the slide, we've planned 2009 adjusted SG&A to be approximately $1.63 billion. As we moved through the year, we took actions on the cost line to offset challenging sales and gross margin trends we're seeing in the businesses.

Specifically, in August we committed to additional cost reductions totaling $55 million. This is what we were referring to on the slide as our 2Q earnings call additional cost-out. Today, after realizing additional cost savings and taking actions to more quickly migrate the Liz brand cost structures to the new business model, we are estimating an additional $25 million of cost-out for this year.

So in aggregate, we are now targeting total 2009 adjusted SG&A to be $1.55 billion. Back in August, we also told you we were looking ahead at 2010 we had initiated an additional $100 million of cost actions. This additional $100 million of cost-out commitment is either fully completed or well under way.

And includes further distribution-center consolidations, additional headcount reductions, streamlining the support functions and rightsizing our production teams to be better aligned with our Li & Fung partners. We still expect the majority of these actions to be completed by the end of this year, resulting in the full $100 million benefit to be realized in 2010.

The recently announced JCPenny and QVC deals further reduce our cost base for 2010 as well, as we will only be responsible for design and co-merchandising, allowing us to eliminate another $65 million of production, marketing, in-store support and back-office costs.

This $165 million of combined cost reduction for next year is expected to be offset by approximately $45 million of investment in our retail platform, marketing and employee compensation, as well as $30 million of anticipated negative foreign exchange translation relating to the weakening dollar.

Let me elaborate on this $45 million of retail growth investment. Costs associated with our domestic-based direct brands' retail platform is planned to increase next year, as we not only annualize the 12 new stores we will open this year, but also the 15 to 20 additional Juicy, Lucky and Kate Spade stores we forecast to open in 2010.

We believe these additional stores offer brand-right attractive growth and profit opportunities. This store growth investment includes all store, people and infrastructure costs associated with our retail platforms.

Further, we plan to increase our marketing spend in 2010 with so many new products, merchandising and e-commerce process across all our brands we need to increase consumer awareness and drive top-line growth. We know that we need to do more than just cut costs. We must also grow sales and margins.

Lastly, over the past year we have dramatically reduced employee compensation and benefits by eliminating the 401K match, deferring all merit increases, reducing bonus payouts, etc. For 2010, if our top-line stabilizes and then operating results significantly improves, we plan to reestablish many of these basic employee benefits.

We will only put these costs back into the P&L if the bottom-line result warrants our doing so. So if all of these pluses and minuses we are targeting a $1.46 billion total SG&A for 2010. As we look forward, we will continue to reprioritize and challenge our cost base as well as our business models and processes in order to, above all, reduce our adjusted SG&A as percent of sales.

Now in order to exceed these levels of dramatic cost reduction, we need to invest restructuring dollars. The faster we get these cost actions completed the more benefit we will realize next year. In the third quarter we incurred approximately $27 million of total restructuring charges associated with these streamlining activities. Over $17 million were cash charges and $10 million were non-cash expenses.

We expect to also incur additional charges in the fourth quarter and are forecasting approximately $40 million in cash and up to $20 million in non-cash charges. These significant charges include severance, asset write-offs and contract termination costs. All of these charges are fully incorporated into our latest cash and liquidity forecast for the remainder of this year and next.

Lastly on our JCPenny/QVC announcement call last month I briefly mentioned that Alvarez and Marcel had completed their review of our working capital, cash management and cost reduction plans. Page 13 summarizes their conclusions. Alvarez was very complimentary of our U.S. operations. They highlighted that our receivables management and metrics were best in class and we successfully reduced inventory levels in order to stay well ahead of the deteriorating retail environment.

They also noted that are cost reduction initiatives and goals were rigorous and well understood across the company. However, they did identify opportunities for us to improve working capital in Mexx Europe where our collection metrics and inventory liquidation efforts are less rigorous. We agree with their assessment and continue to drive the organizational and process changes necessary to realize the associated cash and financial benefits. The Alvarez work is fully complete and net-net their conclusions were favorable and helpful.

Thanks for listening and now we'll turn the call back over to Bill.

William C. McComb

Looking here at page 15, which summarizes the direct brand segment, you see again the comp numbers that I showed at the beginning, a positive trend break beginning in August has improved the outlook on sales. As we discussed for months, the product offering in the back half of the year reflects a stronger presence of opening price points and stronger value without begin overly promotional.

Overall the segment continues to feel the impact of year-over-year changes in wholesale performance where the margin is down and sales revenue are down as well. The operating margin for the segment of only 1.6% highlights the longer term opportunity of this business segment. We still fully believe that these brands can be managed to achieve a double-digit operating margin.

As I indicated at the beginning of the call, we're now seeing flat to positive comps on these U.S. based direct brands. In September, Juicy posted a negative four comp and in October comps were plus one. At Lucky, September saw a negative 26 comp driven by significant price changes in the assortment and it too saw a plus one comp in October.

And Kate Spade has shown a major trend break with comps up 14% in September and then again in October as a new store format that we're rolling out hits, along with significantly improved handbags and the full launch of our apparel business there.

Looking on page 16. International based direct brands, let's take a step back and look at the bigger picture here. There's several challenging issues confronting this business. The first issue has been finding the right management team and now as we've said repeatedly, with Thomas Grody officially on board and the arrival now of six new leaders supporting him. We have the team in place to get this job done above and beyond all else that is a great first step.

Other factors weighing on the current performance, I call out three product, retail operations and declining wholesale. Naturally the economy's not helping while Europe has not been as bad as the U.S. August was a particularly difficult month across the continent.

In terms of the numbers, we saw a major hit in the gross margin line as the company made a big investment in product quality, styling and detailing for fall 2009. Improvements that cost three to four points and have not yet translated into full price sell through during the quarter. This impacts both wholesale and retail gross margin, wholesale in total accounted for 700 basis points of the erosion.

In retail, traffic in third quarter was down 19% and while conversion was up a full point we had to promote to turn inventory. This resulted in a decline in gross margin of 6 points versus second quarter and 10 points versus last year. Much of the impact here came in the month of August usually an important month for full price selling.

Across Europe, August was a very bad month in terms of traffic and comps not only for Mexx but for the market as a whole. We reacted by dialing up the promotion activity which in turn really hit the margin but conditions are improving, declines in sales and margin continue now but at a notably lesser degree so far in the fourth quarter.

On the wholesale front, as the company wavered in the past few years we lost the confidence of our wholesale customer base who had been reluctantly exiting the business now due to multiple seasons of product misses.

They continue to like the brand and our now waiting on the sidelines with great interest given their history with Thomas and his team, with the propensity to re-launch this brand when the execution is seen as right.

In contrast to the U.S., we like European wholesale distribution given better business practices and less consolidation. Thomas Grody began officially in his role on October 1 and his leadership team is coming together with the global head of product encompassing both merchandising and design, the head of wholesale sales, the head of e-commerce, the VP of marketing and the head of retail all in place now today.

Additionally the vice president of visual merchandising will begin on January 1. These leaders come with significant experience in branded apparel retailing in Europe and have hit the ground running. While this is indeed a big turnaround and a tough challenge, the team has the confidence and the experience to build a profit making business and a powerful inspiring brand out of Mexx again.

On page 17, the summary chart for sales and margin in the partnered brand segment, can certainly see why we pursued the JCPenny and QVC partnerships. Sales were down 31% in the segment, gross margin down five points versus year ago levels and the segment posted a negative 7.9% adjusted operating margin.

High levels of promotion and give back in tier two department stores drove these declines while we saw improved margins and sales on our Liz & Co business at JCPenny. We continue to aggressively move the clearance Liz product in our outlets. During the quarter 50% of the goods sold were what we call new Liz which is the Isaac inspired LCNY product. The other 50% was what we've been calling the old Liz clearance product.

The performance differences between these two are dramatic, you can see here. We saw a $22.00 average unit retail price on the new Liz and a $12.00 AUR on the old one. Gross margin was 53% on the new Liz in these outlets and only 27% on the old Liz. We're now predicting that the new Liz will represent 80% of outlet sales in the month of December.

So as we go forward and eliminate this clearance burden, the economics of these outlet stores will improve dramatically. They will improve even more dramatically however when the assortments are 100% designed for outlet and not being sourced out of wholesale show room.

We discussed at length the rational and structure of our new distribution strategy for the Heritage Liz Claiborne business. And if a picture's worth a 1,000 words, then hopefully this diagram on page 18 of the slide will save me 10,000 as I explain what will be happening over the next year by channel.

You see that we'll stop shipping Liz Claiborne New York to the tier two customers after holiday 2009. We have reached agreements with Macy's, Dillard's, Belk, and Bon-Ton whereby they will be accepting deliveries as planned now through December at a dead-net final price with no [posties] and reconciliation or returns.

So we concluded the fourth quarter programs and we're happy with the result. These accounts will have good margin opportunity and we will have an easy transition out of the business in these accounts. Fourth quarter 2009 and first half 2010 remain unchanged in terms of shipping to JCPenny with Liz & Co in its current growing and profitable state.

We will continue selling special cuts to our off priced customers during first half 2010 but that comes to an end in the second half of 2010. Our outlet business will continue to operate as it is today. By spring 2010, we expect to be almost fully transitioned to LCNY product.

And as I said we will be moving to a 100% design for outlet or DFO as we call it model which believe to be the critical link to achieving profitably in that segment of the business. LCNY International also continues to ship to Liverpool and Mexico, [Acort glaze] in Spain and our Canadian franchise remains the same as well.

The second half of next year is then shown in the column all the way to the right with LCNY at QVC, the Liz Claiborne brands at J.C. Penny, and the LCNY at our outlet stores, and in international markets. The Partnered Brand's portfolio, which we will manage to a normalized post-turnaround sustaining operating margin of 6% to 8%, will provide strong capital efficient cash flow.

Page 19 in this presentation here shows the channel and model dichotomy of that portfolio today. So let's step back a minute and take a look at where we are in total. We resolved our company's liquidity position. As Andy indicated, we'll be taking more restructuring charges in the fourth quarter associated with severance payouts, asset right downs, distribution center consolidation, and contract terminations; all that position the company for expanded earnings power in 2010.

We've resolved the distribution conflict and established a profitable model for Partnered Brands. Our new management team at Mexx is in place and we're very confident that they will turn the business. First reducing the magnitude of loss in 2010, and getting to break even or better in 2011. Most importantly, as it relates to the domestic based direct brands, we're encouraged by the comp trend break we highlighted earlier.

We've adjusted in those businesses to the new normal and our assortments are smarter and more value oriented. And consumers are responding. Expanding margins will be verification of the strategy and execution going forward. No question, these brands will take center stage in our conversation with you in 2010 and beyond.

As 2009 enters its final innings, the tone of the business is better but still volatile day-to-day and week-to-week. The consumer is tenuous, but inventories are leaner and that helps the profit equation. For us, fourth quarter will reflect the culmination of many changes making it difficult for you to read our progress as two of our three segments in the fourth quarter will continue to undergo significant transitions.

Having said this, sales trends and gross margins will improve versus third quarter. We see U.S. comps flattish for the quarter overall, and taking into account the impact of reduced wholesale revenues and margin – total company sales will be down 10% to 15% versus fourth quarter 2008 and gross margin up approximately 200 basis points versus third quarter 2009.

As I look back to where we were at this time last year, the changes have been incredible on many fronts. It's been the most challenging period of my professional life with many difficult decisions to be made. I'm very proud of the people at Liz. They've had to change and change and change again because it was completely necessary.

We've had to push hard and they responded. We've accomplished a lot and we're in a much better place than we were 12 months ago. However there's more work to be done on many fronts and we are not letting our guard down. The economy is not in the clear.

You all know, unemployment remains high, national debt levels are rising, taxes are likely to go up, and all of this will weigh very heavily on consumer's willingness and ability to spend. What that means is that we have to give the consumer a compelling reason to part with their money. They have to be inspired by what we are offering. We're in a very competitive industry.

The good news for us is we've got brands with untapped equity and major growth potential ahead. We have room to improve on many fronts; sales productivity, and gross margins as our two most important. From here, even with an uncertain economy, I see our destiny as in our hands now to a greater degree than when I arrived.

The key is to having great leaders in each of our businesses, finding the right distribution partners for our brands and the right distribution models, and executing to the highest standards product and operations. I look forward to keeping you posted on our progress.

With that, we'll be happy to take any of your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Benjamin Rowbotham – Goldman Sachs

Benjamin Rowbotham – Goldman Sachs

I was hoping you might be able to provide a little bit of color around that shift up in the direct brands same store sales run rate in October. How much of that was traffic versus units and pricing?

William L. McComb

It's very mixed across each of the brands or each of the companies. I don't have in front of me right now what the traffic numbers where there in the month of October. We're off cadence. We're giving you guys a peak under the hood and breaking up September and October so that you can see some trend data since we're approaching the middle of this quarter.

But what I'll tell you is this, at Juicy traffic has been down and conversion has been way up. We're seeing in all of the businesses. Let me first say Lucky and Juicy, tremendous increase in unit as the AURs are down - as a strategy we've brought our AURs down.

If you recall we said that we were going to be entering the quarter with a much stronger presence of opening price points. At Lucky, that's manifested itself with a tremendous focus on denim, where 50% of the assortment is at or below $99. And by the way, the turn on that and the lift is tremendous.

In the month of September we didn't see, as we introduced the low price denim we didn't see the increase in units outweigh the loss in dollars. In the month of October we did. So that's how I would characterize it. At Kate Spade it's a very – the phenomenon is it doesn't look like that, we've introduced apparel and that's taken AURs up in the store, and you're seeing sort of an organic explosion if you will in terms of the right product mix and higher AURs.

And as I said I believe we're now at Store 5 on this management team's vision ran - rolled out into a store. We see a huge swing in revenue and profit when we roll that out. So as a result we're going to roll that out to all of our stores by the end of first quarter. The Kate Spade team is probably shrieking, I think that technically it's by the end of April, but we're really excited by it. Hope that answers your question.

Benjamin Rowbotham – Goldman Sachs

No, it does. But bottom line it sounds like X Kate that the demand elasticity is there for the price cuts.

William L. McComb

It looks like its right there. Ultimately, at plus one you call that flat and that is a tremendous achievement in this market. So it does appear to be there, and by the way I only think that right now we're rolling out the true holiday assortments in stores this week actually, and I think it's going to get – I think that equation between unit movement and dollar is going to hold.

Benjamin Rowbotham – Goldman Sachs

Absolutely, and then just one other if I may. The losses at outlet, are those still running about 1/3 of the Partnered Brands Group? I'm sorry the losses that the Liz Claiborne New York outlets are showing.

William L. McComb

I see what you're saying.

Andrew C. Warren

It's Andy. It's a little less than that in the third quarter. I mean as we have a high proportion of new Liz products, the losses are declining so the results in third quarter for outlet are better than 2Q. Again, we expect that to continue to improve in 4Q and first quarter of next year as we migrate more-and-more of the new product through the sales channel.

Benjamin Rowbotham – Goldman Sachs

So in terms of maybe turning a profit there, what do you think the probability is in that next year?

Andrew C. Warren

Well I think it's really going to come down to traffic. We will be north of 90% new product next year through outlet. I think if traffic holds or improves a little bit, I think we have a good chance of making money there.

William L. McComb

I think Ben that it would be a back half phenomenon more than a first half and probably a fourth quarter phenomenon rather than a first three quarter. I think we're gun shy on guiding that will take that from a loss to swing to a positive in calendar 2010.

Obviously, it's our plan for 2011. I can tell you that flat out. And I think that we're – here's what we're happy about. As we continue to expand the penetration of quote, "New product" with all of its price positioning and category nuances and everything, we're glad to see the AUR in the margin differential holding.

And so now what we want to see is we're really letting this outlet team go and letting them out of a cage as it relates to designing for outlet from a merchandising perspective. There have been wear occasions that we've underweighted because they were present and the right weights in the wholesale assortment.

Once that really gets let loose, I think you're going to see a mix shift. It's going to be even more favorable, and as I said that learning – that's all back half 2010 loaded. So I think we're just shy of saying that 2010, the year for profitability but as Andy just said, at the very least we want to close the gap on that loss on that side of the business as much as we can next year. And we've got a great team there.

Operator

Your next question comes from Robert S. Drbul – Barclays Capital.

Robert S. Drbul – Barclays Capital

A couple of questions, Bill, first on the Mexx business, you talked about a lower loss or a smaller loss next year and then sort of breakeven at least breakeven in 2011. Can you just help us frame how big the loss at Mexx this year is expected to be with your expectations currently?

Andrew C. Warren

We haven't really gone through that level of granularity.

William L. McComb

I don't think we can put a number out there.

Andrew C. Warren

There's a significant operating loss for the year. And all of our plans, whether it be through execution, cost out, etc. will get us a better result next year. But this year it's a significant operating loss drain.

William L. McComb

And to sort of circle back to what you're getting at, Bob, since I think that we're both pausing, clutching did not give you the number because I don't think that in any of our disclosures we've broken it out on a separate piece. Thomas, by the way, will be on the next call which is, as you know, in February and that will be his prime time to actually talk about his first four or five month observations and how he's thinking about the plan.

But I will tell you that as you know, first of all Mexx has a long calendar, something that Thomas is already going in and whacking away at. But that this particular team that has arrived, they will be impacting the back half of the year next year. So most of the improvement that I think will flow through, you're not going to see in first and second quarter. And so I think it's important that we say, you know what, we're still going to have some sobering bullet points on fourth, first and second quarter performance because that product it's cooked, it's baked, it's made.

And while we're going to have significantly improved retail operations under Thomas's watch effective immediately and that will definitely help from an execution perspective, I would just tell you to think about the comment that I made about a nice improvement in reducing the size of the loss in 2010 by being back-weighted third and fourth quarter. And it's tens of millions of dollars that we're talking about here, guys. That is a fair characterization of the current loss profile.

Robert S. Drbul – Barclays Capital

So when you look at your fourth quarter expectations around the gross margin, the statement that you made on gross margin, I think 200 basis points better than the third quarter. When you look at the downside impact that Mexx had in the third quarter versus the expectations, how are you planning that gross margin business for Mexx in fourth quarter?

William L. McComb

Well, I mean, it's no secret the advantage of doing the call on November 3, 4 is that we're into the quarter and we have some line of sight into how it's going. And as I said, both the sales trend and the margin trend, while down on a year ago basis, it doesn't look like what the third quarter numbers produced. And so the company weighted improvement of 200 basis points weighted across all the portfolio does take into account what we believe is and will play out at Mexx.

Now, is that to say that there could be – this is a retail business and we are going into the most important six-week period of the whole year. So could there be big swings? Of course there could. By the way, that's true on all of the businesses. But the advantage of speaking to you today is that there is a certain line of sight. And I think that it's a pretty good estimate, that 200 basis point improvement, including the downside pressures at Mexx.

Robert S. Drbul – Barclays Capital

One last question from me is, on your slide 15 the recent comp sales by month, can you talk about the two-year trend for the third quarter by brand versus what you saw happen for the two-year trend in October?

William L. McComb

No, because we've never, I mean to be honest with you, I don't have the monthlies out here on the table in front of me. We don't usually report them out this way. Like I said, this is a special treat we're throwing you and as a result I don't have in front of me what that looks like.

Operator

Your next question comes from Omar Saad – Credit Suisse.

Omar Saad – Credit Suisse

Bill, I noticed a little bit of a change on your tone from the last call to this call, it sounds like some of the recent comp data has helped with that. But is your view on kind of the industry profitability, the outlook for industry profitability this holiday season, the level of discounting that you expect out there, has that changed at all since the last time you spoke to us on the phone?

William L. McComb

Well, you're 100% right. I mean, if you recall, I was the grim reaper as I talked about what could happen in the fourth quarter back in August. And you're definitely hearing, now that we're a full month into the quarter, you're definitely hearing that.

To Ben's question, I had indicated in August that one of the things that I was worried about from a forward-looking perspective was with the prices coming down, which was an important smart consumer based adjustment, what was the demand elasticity there to in fact have the units make up the lost dollar volume? And I'm more bullish on that today than I was back in August.

All that said, of course there still are several weeks in front of us and crazy things could happen, but I think the inventory situation is the other big callout I would give. It's absolutely clear that inventories are light to bordering maybe on too light as a marketplace in total. And I think that that bodes well for not letting a lot of opportunistic behavior happen.

I'll tell you, it certainly helped us in the clearance discussions on the Liz Claiborne product. Frankly, those retailers, as we predicted, those retailers want and need those gross margin dollars. And they were really looking to take the discounts we were offering to move the product through on a dead net basis.

So I think between the view of what inventory is out there and the sense that there's an elasticity, which by the way ties into the inventory situation, but that there's a nice elasticity in response to these opening price points. I definitely feel a little less melancholy about what the fourth quarter could have brought.

Omar Saad – Credit Suisse

Andy, if I could on the partnered brand segment, obviously a significant loss year-over-year, kind of a change in the profitability in that segment, not a big surprise to anybody. But can you help us understand the dynamic of the Liz Claiborne piece within that? Does that account for much of that loss? And is that kind of what we should think about going away from a loss perspective comparing to a profit protective?

Andrew C. Warren

Yes, for sure. I mean, it's a major piece of the operating loss, Omar, and it certainly is also dilutive to the gross margin line as well. So I mean, Liz Claiborne at wholesale has been a real drag on all of those metrics year-to-date and so that will turn dramatically as we go into the new models here in 2010.

William L. McComb

I think that that also is a big part of the change in tone you're hearing from me. I mean, I really feel like that plus that full conversation that we just had on outlet, I think there's a path clear here for this to be a profitable and stable cash contributor to us. And then you add to it the sense of confidence that I have in this management team at Mexx and it just kind of, it gets you to where the tone that you're hearing.

Operator

Your next question comes from Mary Gilbert – Imperial Capital.

Mary Gilbert – Imperial Capital

I had a question looking at the Liz business that's going away. Basically when I say going away, transitioning to the licensing model. I wondered if you could help us in any way in giving us an idea of the magnitude of the Liz business at JCPenney and understanding that that's going to grow because it's in so many categories and its going to expand across all categories. And then also with the remaining Liz business or the LCNY business that's going to transition to QVC and the opportunities and how we would look at that licensing business model.

William L. McComb

Well, a couple points and then I'll let Andy chime in on this as well. Keep in mind what's going to happen is, and you go back to that one page where I lay out in those different bars the dynamics of it. What happens is when you get to third quarter next year, what were wholesale sales and coming in the revenue line as top line sales at JCPenney in the form of Liz & Co. goes away and shows up as royalty income in our P&L.

So there's a major apples to oranges modeling transition here. We aren't giving retail sales. We've had a lot of questions about providing some level of guidance around what we think that level of royalty will look like. We haven't provided that. Any comments, Andy?

Andrew C. Warren

Just to quantify some of that, Mary, the notion here is today we have a negative operating margin on about $300 million of wholesale sales. That's what we've highlighted before. And now we'll transition in 2010 to a very high margin royalty rate. So, expect a lower net sales but a dramatic change in operating margin to profitability from today's negative to a positive virtually 100% margin royalty rate going forward.

Mary Gilbert – Imperial Capital

Now will we see the benefit of also the share in gross margin do you think in the first year? Or does the gross margin share kick in after the business reaches a certain level?

William L. McComb

No, it kicks on day one and it's done quarterly, a quarterly reconciliation.

Andrew C. Warren

So we should see the benefit of that starting in August because the launch of the product at JCPenney would be in August and all of those deal elements included in the gross margin share will happen then.

William L. McComb

It's how we get paid so.

Mary Gilbert – Imperial Capital

Well you get paid two ways, one is a percent of revenues and one is a percent of units per share.

William L. McComb

But they're both important.

Andrew C. Warren

And they're both day one.

Mary Gilbert – Imperial Capital

Then the other thing is, year ten is there a purchase agreement, because it sounded like looking at the language that the business would then revert to JCPenney. So is there actually a purchase option?

Andrew C. Warren

Well, the way the deal works, Mary, is at the end of year four JCPenney has really three options, either to acquire the brands in the U.S. and Puerto Rico, to extend the deal or to send the marks back to us for the end of year six. So if they choose to extend and pay the minimums through years five through ten, they will at the end of that period own the marks.

So we're very comfortable with that those minimum royalty rates and the deal constructs allow us the right level of profitability and cash flows where they will have earned and properly paid for those marks at the end of year ten. And again only in the U.S. and Puerto Rico.

Mary Gilbert – Imperial Capital

So does that suggest that that rate is probably higher than the traditional market rate that you see for licensing arrangements?

Andrew C. Warren

We're not going to comment on that.

William L. McComb

I don't think we're commenting except to say that the spirit of this deal is that there is a sharing of upside that takes place. And the whole idea of having both a fixed royalty and a GP share that's variable is to allow each other to first of all be aligned with each other's goals and to work together to reduce costs and maximize total margin. But to be able to enjoy some upside on our side of the deal, to be able to enjoy some upside that happens. It's really a new model. This is very hybrid. There really isn't one out there that we've seen that reflects all of the different elements of this.

Andrew C. Warren

And just to add another point to that, Mary, it's very important to note that while there are minimums and we're comfortable that those minimums over the ten-year window reflect a great value for us. All the teams are working towards numbers much greater than those minimums. We think the profitability of this brand at JCPenney is going to be such where the minimums are just a baseline and expectations are much higher.

Mary Gilbert – Imperial Capital

Then one last thing and I'm sorry to focus on the licensing model, but it's very intriguing. It's difficult to come up with what the magnitude of business could be for QVC. Is there anything that you can enlighten us with on how to look at that portion?

William L. McComb

Not on this call. I think that maybe – I mean keep in mind – first of all, that's what I'm going to call more of a traditional model where there is a fixed royalty as a percentage of sales. And there are minimums. It's confidential information on the part of QVC and I wouldn't use this opportunity to disclose it.

We're working through business plans with them right now. They are a great partner, they love this property they are key item driven. There are a lot of things that, with Isaac designing, that we can do that are going to be exciting. And right now, I don't have any other guidance other than what we know to be the minimums but that's an internal piece.

And by the way, I would say that it's the kind of thing where it's a question that QVC should answer, I mean, frankly. They give information in their presentations on their apparel mix and the role of top brands from the dollar perspective in their overall basket. So I would point you to them. I would say it's not trivial to us. It's important enough and significant enough to put the effort against it and to make it happen.

Operator

Your next question comes from Jennifer Black – Jennifer Black and Associates.

Jennifer Black – Jennifer Black and Associates

As a follow-up to QVC I wondered if the Liz Claiborne line will be just apparel and accessories, could there be other categories as well? And will the hours aired be during primetime or is that something that you don't know?

William L. McComb

I don't yet know what the scheduling is. I mean the beauty of QVC, as any great direct marketer, they do all kinds of different things and they test and react, test and react to different time slots and time pods and different formats. It is an all-store, if you will, all-category license and they do a great home business and we anticipate that they'll use the home categories in addition to apparel and accessories.

E-commerce is also very big for them, by the way, as well as for Penney's. One of the things we've pointed out and I would just point to you again, don't underestimate the power of both of them, Penney's and QVC with their e-commerce platforms. It's one of the things that we loved, as we were moving from a traditional brick and mortar department store environment. We're intrigued by what both of them will be doing there. But it's home and all categories, apparel, accessories and home.

Jennifer Black – Jennifer Black and Associates

Would there be any new categories that you don't currently have licensed now, that you don't even have now?

William L. McComb

I think so. I won't name specifically what they are, but they're talking about some areas that we've been maybe in the past that we aren't in right now. And I know that fragrance is an area that they would like to consider a return to.

Jennifer Black – Jennifer Black and Associates

Then I wondered if you could talk a little bit more about Juicy. Is it both apparel and non-apparel that is coming back and are you doing anything new as far as marketing? And how are the wholesale accounts responding as far as future orders, both with Juicy and also Kate Spade which I know you just launched?

William L. McComb

I would say as a call-out, both apparel and accessories are doing well. They're both responding. I would say they're evenly represented in the trends at Juicy that we've talked about. In terms of newness, the Bird line is virtually a sellout item, a sellout line I should say. And while it's in very limited distribution, just a few doors in department stores, just a few of our retail stores, we've definitely caught something there.

And what it does it offers something from Juicy that's distinct and more sophisticated for the I'm going to say 28 plus – the girl that grew up with Juicy that's now 28, 32 even 40. So we're excited about Bird and what we can do with that because we virtually haven't even taken it anywhere else. You probably have seen the Do the Don'ts ad campaign which is very visible and that really represents a different look and a push in the attitude and voice of the brand. And we believe that that's doing extremely well.

In terms of wholesale, I'll be very honest with you. One of the reasons that we're actually calling the company sales line down in fourth quarter 10% to 15% versus year ago is that just across the board wholesale continues to contract. And at Juicy that's especially true on the apparel side. We don't think this is a bad thing. As I've said, it's been a big and important profit booster for us and a very important avenue and access to a consumer. We're going to still have that. I think that their reducing their apparel footprint and we are supportive of that because it's moving and turning well in our retail stores.

At Kate Spade, it's an expansion mode. We launched apparel, it's doing very well. The wholesalers are very happy with it and we are being careful about what doors we put it into from a wholesale perspective because our strategy and focus is four wall productivity of a now significant retail chain.

Jennifer Black – Jennifer Black and Associates

Have you made any adjustments on Kate Spade apparel to the price points?

William L. McComb

None at all. And I will tell you, you can take this to the bank, the highest priced items are selling through the fastest. It's incredible.

Operator

Your next question comes from Chi Lee – Morgan Stanley.

Chi Lee – Morgan Stanley

Andy, a quick clarification question on a comment you made earlier in terms of the current Liz Claiborne business as being gross margin dilutive. When you say dilutive, are you referencing that relative to what's been about a 35% average gross margin rate for partner brands, or in fact are they actually negative from a gross margin perspective?

Andrew C. Warren

It's diluted to 35%, Chi.

Chi Lee - Morgan Stanley

And then with regard to the A&M findings, could you directionally help us understand what potential working capital opportunities there could be as you address some of the issues that were raised within Mexx Europe?

Andrew C. Warren

Sure. Again, they were very complimentary of all the stuff we've done domestically, so I'll focus their comments on Europe. We have been working through this. I hired a new CFO over there early this year. He's been diving into opportunities around liquidating of old inventories.

Clearly we have some aging receivables, particularly out of Eastern Europe, that we just have to get more aggressive on. And there is a large number of bank accounts just given how the European structure works that we're going to consolidate in order to lower some of our cash balances and have that go to pay down debt.

So net-net, it's definitely call it $10 million to $20 million working capital opportunity out of Europe for us, and it really is about execution, about getting the right people in the right jobs, and that's what we're focused on right now.

Chi Lee - Morgan Stanley

And over what period of time do you think you could actually recognize that $10 million to $20 million opportunity?

Andrew C. Warren

Look, I tell you, we've already made some of the organizational changes literally in the last couple of days.

William L. McComb

And it also helps to have a CEO in place. You've got a great CFO that's now got a partner in a CEO and I think to take some objectives and goals from Andy and I, I think these guys can drive this in a six-month period.

Andrew C. Warren

Yes, I think the next six months we're going to see a lot of this being realized.

Chi Lee - Morgan Stanley

And just last question. When you mention that you sold it at a debt net term in terms of the balance of the LCNY business, is that basically relieves you of any additional markdown liability as a result of the clearance activity. It's sort of out the door and done for you guys at this point?

William L. McComb

That's exactly right.

Operator

Your last question comes from Jim Chartier - Monness, Crespi, Hardt & Company

Jim Chartier - Monness, Crespi, Hardt & Company

I was wondering if you could let us know what the comp sales for the Liz outlets were in first and second quarter and if the down 13% was an improvement in third quarter?

William L. McComb

Let's see if we've got it here. Hang on just a second, got to flip through some papers. I'm probably going to have to send it to you on email, Jim. By the way, it's online in these presentations from first and second quarter. You'd find it in those decks. I just don't have it here in front of me.

Jim Chartier - Monness, Crespi, Hardt & Company

And then as far as the marketing spend increase?

William L. McComb

And by the way, it's definitely improved, to answer your question.

Jim Chartier - Monness, Crespi, Hardt & Company

And then if you could just give us an indication of where you expect the market dollars to increase next year versus domestic direct brands, if you're doing any marketing for the Liz outlets.

William L. McComb

Nominally, it's Lucky, Juicy, Kate, and a little bit in Mexx for the third and fourth quarters.

Jim Chartier - Monness, Crespi, Hardt & Company

And then how do you plan to improve the traffic to the outlets for the Liz Claiborne?

William L. McComb

I will be honest with you, I think that the greatest thing of all is the amazing halo of expanded awareness that will be created at Penney's and at QVC and that's always that model. You don't separately market outlet stores. The strength of the primary channel marketing is what makes the residual traffic work well and I think by having partners that market the brand for once, I think it's going to be extremely helpful.

Jim Chartier - Monness, Crespi,, Hardt & Company

And is it too early to tell how the Li & Fung agreement is working for you? Are you pleased with that? Is it going better or worse than expected?

William L. McComb

No, we're definitely still in the process of gelling from a team perspective. There are pockets of huge success and areas where we're still struggling to make certain elements of it work. But to be honest with you, the 200 basis point of improvement in the fourth quarter versus third quarter at a time when we're also bringing price points and AURs down wouldn't have been achievable without their help. So answer, we're happy.

Jim Chartier - Monness, Crespi, Hardt & Company

And then finally, you mentioned the currency impact on SG&A next year. Can you tell us what the impact on sales you expect for next year from currency?

Andrew C. Warren

No, we're not going to provide that right now. We could do that maybe as we provide more context on 2010 on the next call, Jim, but clearly this weakening of the dollar is creating some cost pressures. We should get some off-setting benefit to the top line obviously and we can provide more clarity on that later.

William L. McComb

Operator, time to wrap.

Operator

This does conclude this Q&A portion of today's conference. I will now turn the call back over to Mr. Bill McComb for closing remarks.

William L. McComb

That's it. Thank you all for dialing in and look forward to talking to you again at year-end.

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Source: Liz Claiborne Inc. Q3 2009 Earnings Call Transcript
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