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Ann Taylor Stores Corporation (NYSE:ANN)

Q3 2009 Earnings Call

November 20, 2009 8:00 am ET

Executives

Kay Krill – President & CEO

Mike Nicholson – EVP & CFO

Judith Pirro – Director IR

Analysts

Adrienne Tennant - Friedman, Billings, Ramsey

Michelle Tan – Goldman Sachs

Neely Tamminga - Piper Jaffray

Tracy Kogan - Credit Suisse

Laura Champine - Cowen & Company

Roxanne Meyer - UBS

Stacy Pak – SP Research

Jennifer Black - Jennifer Black & Associates

Lorraine Hutchinson - Bank of America

Kimberly Greenberger - Citigroup

Jeff Black - Barclays Capital

Janet Kloppenburg - JJK Research

Operator

Good morning ladies and gentlemen and welcome to the Ann Taylor Stores Corporation third quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Judith Pirro, Director Investor relations; please go ahead.

Judith Pirro

Good morning everyone. I’m here with Kay Krill, Ann Taylor’s President and CEO and Mike Nicholson our CFO. As you know earlier this morning we issued our results for the third quarter of fiscal 2009. Kay and Mike will provide an overview of the quarter, update you on our outlook, and then we’ll open the lines for questions.

Before turning it over to Kay, we would like to remind you that our discussion this morning includes forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially.

With that, I will hand it over to Kay.

Kay Krill

Good morning and thank you for joining us. I’m pleased to update you on the progress we’re making, some of which can be seen in the earnings we reported for the third quarter. While the environment remained challenging during the quarter and the top line continued to be pressured, our operating earnings benefited from our continued focus on the strategy we have been employing throughout the year.

A strategy that calls for us to maximize our gross margin dollar performance. To that end I am especially pleased to report that all of our divisions achieved significant increases in gross margin rate during the quarter with LOFT nearing its historic high.

Consistent with what you have heard us say many times this year, we believe that the current environment and its impact on our clients, particularly the Ann Taylor division has caused us to take an even more prudent and disciplined approach to the business. That has been our mantra all year and it is working.

Our strategy has focused on making our inventory investment as productive as possible allowing us to generate better full priced selling and keeping our merchandise edited, fresh, and compelling. On the top line our overall sales showed some improvement on a comp basis versus the second quarter, though we came in slightly softer then we expected.

Looking at the quarter as a whole, comps were weakest in August at both Ann Taylor and LOFT and improved as new merchandise flowed into the stores and we rebuilt our inventory position to meet the consumer demand.

In fact, the Ann Taylor division reported a better then 25-point improvement in comps from August to October, while LOFT generated a near 10-point improvement. Our objective is to rebuild sales volume as we move into 2010 while continuing to be smart in our inventory buy in this macro environment.

Its worth noting that a valuable benefit of our healthy inventory position has certainly been our ability to be more strategic in our promotional strategy. At both Ann Taylor and LOFT we were able to scale back less profitable promotional activity during the quarter, focusing more on brand building and competitive positioning rather then inventory clearance.

In addition to our inventory management and strategic promotional activities, our bottom line also benefited from the savings generated from our structuring initiative. Mike will walk you through that aspect in a few minutes.

Let me just say that overall our company is operating more efficiently today and that is translating into higher levels of profitability. From a financial perspective we have focused on keeping our balance sheet strong and are very pleased to report that we ended the quarter in an excellent position with $134 million in cash.

This is after we repaid the $75 million that was outstanding on our revolving credit facility. We now have no outstanding debt. Let’s now turn to our brands, I’ll start with Ann Taylor.

As you know the third quarter marked the beginning of our multi season effort to reposition the iconic Ann Taylor brand. While top line comps remained constrained for the quarter we did make progress in reversing the trend decline in the last several quarters, as well as within the third quarter itself.

At the same time we improved gross margin performance. No question we still have work to do, but we feel we’re on the right path towards revitalizing and rebuilding the brand for today’s consumer. Notably sales at the division improved dramatically over the course of the quarter as our new fall assortments flowed into stores and marketing efforts began to gain traction.

As you know from our prior call we entered the quarter in a lean inventory position having successfully cleared our prior season product. This gave us a fresh start with the launch of our new collection. In retrospect perhaps we may have been too lean in August as we flowed in deliveries of new product and rebuilt a more robust mix of full price and non-full price merchandise, we saw store metrics improve progressively.

But given the uncertainty regarding consumer confidence in spending, and with the national unemployment rate over 10%, our approach was prudent for the time. Going forward we intend to ensure that our inventory positioning supports our growth strategy as we move forward into 2010.

We have said from the start that we expect Ann Taylor’s repositioning to be an evolution not an overnight change and as such we have viewed this initial period as a time of intense learning, reading, and reacting for the brand.

We have stayed very close to our client and are carefully monitoring our performance to best understand what is working and how to build on it and what is not, so we can course correct. We’ve had some early [hits] to build on and see evidence that our clients are noticing the difference in Ann Taylor’s style, quality, and value.

Specifically we saw strength in our new suiting during the quarter as well as dresses, pencil skirts and jackets. The client has also responded to our perfect pieces which are new core essentials across product categories and they have also consistently over performed their inventory.

Non-apparel has also been very strong with jewelry, shoes and belts all exceeding our expectations. We chased several categories that performed well during the fall and because our sourcing processes have improved over the past year, we are better able to chase select products within the season.

We had less success with tops overall including sweaters and woven’s. We needed more diversity in the offering and color, silhouette, and fabrication as well as more balance between fashion and core essentials. In addition to tops, pants also under performed for the quarter.

We believe we did not have enough diversity in pant legs and the client responded more positively to our skirts and dresses. In terms of marketing we supported the new product with a cost effective, yet very impactful strategy designed to spread the word about the new Ann.

Our approach was multifaceted, from more effective window graphics and increased digital marketing to investment in valued added print advertising and PR. As one example, we tested heavy [up] marketing in two markets; New York and Chicago, where we saw strong results.

We also continued to keep our clients engaged through direct mail and email outreach. Overall we feel good about the results from our marketing efforts and are pleased at the incremental spend for the quarter, was fully funded by the improvement we saw in gross margin dollars from the second to the third quarter. Our promotional stance for the third quarter was much different from Q2 and prior periods when much of that activity was dictated by inventory clearance.

By contrast in Q3, our focus shifted to drive more profitable traffic and conversion with key promotions built in during the quarter to entice our client and introduce her to the new Ann. Even with this activity we were less promotional on an overall basis versus the second quarter and we saw this reflected in our gross margin rate and in our full price penetration which was up significantly over both the second quarter and a year ago third quarter period.

As we look to the fourth quarter we believe we’ve made progress as we continue to refine and evolve the brand. We have entered the quarter in a healthy inventory position and with a product mix that is much more current then last year.

From a product standpoint the offering is highly focused on versatility with styles that go easily from desk to dinner. Our client wants to buy product that meet her many lifestyle needs. As you recall last year the assortment was much more occasion driven.

By contrast this year the significant part of our mix is versatile separates and dresses, jewelry, accessories, and cashmere. We believe these categories represent compelling self-purchase opportunities as well as great gifting options.

I’m also pleased to say we are far more colorful versus the third quarter of this year and the fourth quarter of last year. From a pricing standpoint while we believe the assortment represents tremendous value, we also recognize the client is far more price conscious today. So we will continue to monitor our pricing structure to be competitive.

While its too early to make any meaningful forecast based upon the product mix, and the current top line run rate at the division, we currently expect to achieve sequential improvement in the division’s total sales dollar performance as compared to the third quarter level.

As far as gross margin we expect the fourth quarter will be promotional and we are prepared to execute on various incentives to remain competitive in the marketplace and to continue to drive traffic, build brand momentum, and ultimately sales.

Importantly we have made some key changes in our promotional strategies versus last year to better appeal to our clients’ current purchasing habit and make her feel smart and good about her spend. Based on the higher level of promotional activity anticipated we expect fourth quarter gross margin to be lower versus the third quarter but substantially higher then last year’s fourth quarter.

From a marketing and PR perspective we will remain proactive in our outreach and are very excited about our new campaign featuring Heidi Klum. All in all I’m encouraged and feel that we’re on the right path in many respects and will continue to proceed thoughtfully as we evolve this brand.

Let’s now turn to LOFT, overall LOFT delivered a good third quarter. Our product, marketing, and inventory management strategies worked together to enable us to deliver a dramatic increase in gross margin, significantly higher full price sales and improved comp store sales from the first and second quarter.

Underpinning our progress has been our continued focus on improving our gross margin and managing our inventory. This has been a priority all year but was especially effective this quarter with LOFT approaching a historically high gross margin rate.

As you will recall it was our plan to enter the quarter with significantly lower markdown merchandise. In fact markdown inventory accounted for less then 20% of total in store units across the quarter versus almost 40% last year.

But this is only a small part of the LOFT story, central to the division’s performance has of course been product. Our team has continued to strengthen and evolve the offering and has been successful in both honing in on what our client wants from us, as well as identifying new opportunities.

A key case in point is our casual business where we saw excellent results this quarter, from an expanded denim and knit assortment. Both categories delivered very strong double-digit comp store sales increases and substantially high gross margin dollars.

We also had strong performance in dresses, accessories, jewelry, and all tops. A highlight of the quarter was the launch of our LOFT lounge collection, which we delivered in September and this new product category generated an outstanding response.

This collection is knit based and is a natural extension of our existing casual business. Based on the strength of the product and our clean inventory position, we scaled back promotional activity in the third quarter opting to shorten certain promotions versus last year.

We remain very much in tune with the current consumer desires to have incentives to shop and therefore we intend to drive traffic and sales by promoting more aggressively at LOFT as we move through the holiday season in order to get our share.

In terms of marketing we strategically increased our investment for the quarter and have been pleased with the results. The focus was on keeping our client engaged and creating increased excitement around the product offering and brand.

For example, we enhanced our windows and in store visuals, increased our visibility within the fashion media, expanded advertising in select markets, and rolled our successful in store events at many of our most productive locations.

In addition the relaunch of LOFTonline.com has been a huge win. Looking ahead we believe that we have entered the fourth quarter with a compelling product assortment and a solid marketing plan. As with Ann Taylor versatility remains the key to the apparel assortment from every day to weekend.

We also continued to differentiate the brand on the basis of compelling, relaxed fashion, and value and are maintaining the inventory management strategy that contributed to our gross margin success in the third quarter.

However we don’t expect a repeat performance in the fourth quarter in terms of reaching the near record gross margin rate we achieved in the third quarter. This is entirely due to the anticipated promotional environment and our plan to offer competitive incentives.

Nevertheless we still expect to deliver significant improvement in gross margin versus last year. With the business on healthy footing we are excited about the opportunities that lie ahead for this division. Our goal is to further strengthen LOFT’s position as the destination for feminine, casual, stylish product at great value.

Let’s turn briefly to our factory and internet businesses, overall during the quarter we saw improved performance in the factory channel. Both sales and gross margin dollars improved versus third quarter last year. As the consumers’ mindset remains very price conscious, this channel was productive for us, in fact delivering a positive comp performance by quarter end.

As an aside, for LOFT Outlet the quarter marked the one-year anniversary since launching this business and we are pleased with the progress we’ve seen in this first year. Moving on to the results in the e-commerce channel, we opened the quarter with a relaunch of updated and enhanced Ann Taylor and LOFT websites which coincided with the repositioning of Ann Taylor.

Our focus was on beautiful distinctive and brand right design, significantly improved product photography, and easy to use navigation. The response from clients was strong and both traffic and sales increased after the launch.

In fact, September online traffic results were up more than 20%. Our focus on gross margin dollar performance also extended to the e-commerce business where we delivered a substantial increase in gross margin dollars.

In summary I feel good about the progress we made this quarter and that the steps we’ve taken to manage through an uncertain retail landscape enables us to achieve improved performance versus the second quarter and last year.

Now let me turn it over to Mike for a more detailed review of the financials.

Mike Nicholson

Thanks Kay, and good morning everyone. Today I’ll start with a summary of results for the third quarter and then I’ll provide you with some perspective on our outlook for the remainder of the fiscal year.

Beginning with net sales, net sales for the quarter were $462.4 million, a decline of 12% versus the $527.2 million in net sales reported in the third quarter of 2008. By division, net sales at Ann Taylor were $112.3 million versus $159.5 million reported last year.

At LOFT net sales were $234 million versus $263 million reported last year. Comp store sales for the quarter decreased 13.7% with Ann Taylor down 25.8% and LOFT down 9.7%. As we’ve said previously our third quarter strategy was focused on maximizing gross margin dollars, not comp performance while mitigating inventory risk.

Which leads me to our margin discussion, our third quarter gross margin rate was 57.3%, significantly above the 48.8% rate reported in last year’s third quarter and ahead of our own earlier expectations. Our outperformance during the quarter was primarily a result of conservative inventory levels which allowed us to promote very strategically throughout the quarter.

All of our divisions and channels delivered strong gross margin rates during the quarter especially LOFT which operated at near peak gross margin levels. Turning to inventory, total inventory per square foot declined 20.7% versus the third quarter of 2008.

By division Ann Taylor’s total inventory per square foot which includes items in transit, declined 17% and at LOFT total inventory per square foot declined 19%. We are entering the fourth quarter with inventories again positioned conservatively. Carry over inventory which we define as our September store set and prior, was down more then 70% at both Ann Taylor and LOFT.

We are pleased that our inventories are this clean and have such a low level of carry over in the mix. As a result during the fourth quarter we will have the opportunity to incent our clients with more current product at both divisions if necessary, to remain competitive in what we believe will be a highly promotional retail environment.

As Kay mentioned we are bit lighter on inventory at LOFT then we’d like to be heading into the fourth quarter but we have chased product into the holiday season and importantly as we move forward into 2010 we intend to ensure that our inventory positioning supports our growth strategy.

Turning now to SG&A, SG&A declined approximately $9 million versus the prior year, a 3.4% decline relative to a 2.5% declined in weighted average square footage. This improvement in the third quarter reflects restructuring program savings, offset by an overall increase in marketing activities as well as an increase in performance based compensation.

Turning now to our strategic restructuring program, our restructuring program remains on course and we continue to expect it to generate approximately $125 million in ongoing annualized savings over the three-year program period ending in fiscal 2010.

We realized approximately $40 million of these savings in 2008, and we expect incremental savings in 2009 to total approximately $60 million. The remaining incremental program savings of approximately $25 million are expected to be realized in 2010.

In terms of restructuring program costs, we anticipate minimal incremental costs for the remainder of fiscal 2009. Third quarter pre-tax restructuring costs were approximately $600,000 with an EPS impact of less then a penny per share.

As a reminder restructuring program costs for 2009 are estimated to be approximately $30 to $35 million. During the third quarter we also incurred asset impairment charges related to underperforming stores. On a pre-tax basis these charges totaled $15.3 million with an EPS impact of $0.16 per share.

Excluding these restructuring and asset impairment charges, we reported operating income of $18.7 million during the quarter compared with operating income of $2.4 million last year. On the same basis we reported third quarter net income of $12 million or $0.20 per diluted share compared with net income of $1.6 million or $0.03 per share in the prior year.

Weighted average diluted shares outstanding for the quarter increased 3.2% to 58 million shares versus the 56.3 million shares in the third quarter of 2008. Our effective tax rate for the quarter was 1.7% versus 33.6% in the third quarter of last year.

The effective tax rate for the quarter primarily reflects the adjustment required to reflect an increase in our estimated effective tax rate for the full year period. Depreciation and amortization in the third quarter totaled approximately $26 million versus $33 million in the prior year.

Capital expenditures for the third quarter totaled $3 million versus the $28 million in the third quarter of 2008 and for the year we continue to expect total CapEx to be approximately $35 million. Our square footage at the end of the quarter totaled nearly 5.5 million square feet, down approximately 3% from the prior year quarter and on an end of period basis, and down 2.5% on a weighted average basis.

During the third quarter we opened one LOFT store and closed one Ann Taylor and one LOFT, ending the quarter with 932 stores. In addition we converted one Ann Taylor store to LOFT. Now I’d like to spend a moment discussing our real estate portfolio strategy which has been an area of particular focus during the past quarter.

Overall we are in the process of completing a rigorous portfolio analysis with a goal toward optimizing the market positioning of our stores at each division and enhancing profitability per square foot over time.

While this review is still underway and will continue through the remainder of the year, we have so far identified 11 Ann Taylor store locations that we believe would be ideal for our LOFT brand due to the size of the stores, and the casual nature of the centers.

We plan to convert these stores in fiscal 2009, one of which has already been converted in the third quarter. We anticipate that this ongoing review of our real estate portfolio will yield more opportunities to enhance the productivity and profitability of both brands.

As is our practice we will provide you with a comprehensive update on our 2010 store plans for each division during our year end call in March. Turning now to our balance sheet, as you may recall earlier this year we drew down $150 million from our revolver as a precaution against uncertainty in the broader credit markets.

Given the external environment at that time this was a prudent measure taken as insurance rather then out of need. As anticipated we never had to use any of that cash and our objective was to repay that outstanding draw down by the end of the fiscal year and we did so by the close of the third quarter.

We ended the quarter with no outstanding debt and $134 million in cash on hand. In terms of operating cash flow we increased cash by approximately $8 million during the quarter. Looking ahead to the fourth quarter I’d like to provide you with a framework to use as you think about our performance.

First, we expect total sales in the fourth quarter to be slightly below those we achieved in the third quarter of 2009. That said we do anticipate sequential comparable store sales improvement in the discrete period.

By division we anticipate comparable store sales for the fourth quarter at Ann Taylor in the negative low to mid teens and at LOFT based on the current trends we anticipate fourth quarter comps to be flat to slightly positive.

Turning to our gross margin expectations, although gross margin performance remains a focus for the fourth quarter, we expect that our anticipated higher promotional stance in the fourth quarter will result in softer gross margin results relative to the third quarter although considerably stronger then the levels achieved in the fourth quarter of 2008.

We expect fourth quarter SG&A expense to be approximately $245 million, $20 million below the $265 million in SG&A we reported in the fourth quarter of 2008. We will continue to tightly manage our expenses while continuing to make prudent marketing investments in our brands during the fourth quarter.

We expect that total square footage will decline approximately 2.6% at year end or 1.2% on a weighted average basis, reflecting the impact of 45 stores planned for closure in fiscal 2009 under our restructuring program partially offset by the opening of 14 new stores.

Of the approximately 45 planned closures, 28 are anticipated to take place in late January. In addition we plan to convert approximately 10 Ann Taylor stores to LOFT in the fourth quarter. And finally we will continue to focus on maintaining a strong balance sheet and expect to achieve a year end cash position in excess of our fiscal third quarter 2009 cash position.

And with that, I’ll turn it back to Kay.

Kay Krill

Thanks Mike, overall we continue to anticipate that the environment will remain competitive in the fourth quarter, especially in discretionary areas such as apparel. As we said we fully expect to step up our promotional stance during the fourth quarter to drive business and we have factored this into our outlook.

Overall we remain committed to managing the business prudently with a focus on the growth of our brands and maintaining a healthy balance sheet. That said, I believe we are entering the fourth quarter in a strong position based on our product offering and our healthy inventory position.

We have also developed marketing and promotional strategies to drive both near-term sales and longer-term brand building. The investments we are making in our brands are beginning to show results and we are very excited about the opportunities that lie ahead.

With that let’s open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Adrienne Tennant - Friedman, Billings, Ramsey

Adrienne Tennant - Friedman, Billings, Ramsey

My question is on the comps, especially at LOFT, so the total comp is a negative 10, the spread between August and late October is about 10 points, and as we go into the fourth quarter there’s guidance for the flat to slightly positive, are we to assume that you did not see this drop off in late October and in fact the October comps going into November were maybe in the negative low single-digit range. What gives you the confidence that particularly at LOFT could go positive and then the improvement at the Ann Taylor stores.

Kay Krill

Yes, LOFT was, we did have a stronger October, absolutely then August and September. And LOFT was somewhat, a little bit softer before their holiday store set hit the floor at the end of October and I think it had to do with their clean inventory position more then anything else.

Clients expect a little bit of mix of full price and markdown product in October and we were very, very clean. Since the November store set hit at the end of October we’ve seen positive results in the LOFT division.

Adrienne Tennant - Friedman, Billings, Ramsey

Is that positive comps or sequentially positive.

Mike Nicholson

Sequentially positive.

Adrienne Tennant - Friedman, Billings, Ramsey

And then at the Ann Taylor stores division, similar pattern in terms of the cadence in the back half of October.

Mike Nicholson

I think its fair to say that at the Ann Taylor division that we did see to Kay’s point during the call, that we did see a fairly significant uptick in the month of October as compared to the quarter in general and we continue to see that trend moving forward into November.

Kay Krill

Correct.

Adrienne Tennant - Friedman, Billings, Ramsey

Okay, that’s great, because its tough out there right now. Any significant promotions or traffic driving incentives that we should be aware of as we go into Black Friday. I assume they’re all planned.

Kay Krill

That’s all hush hush. You have to go to the store to see that. But we are very, we have been very planful about that. We have been testing throughout the past 30 days in different sells and districts to see what the stronger results are. And we’re very, very, we’re very on top of that and have projected I think a very powerful Thanksgiving promotional strategy for both brands and all channels.

Adrienne Tennant - Friedman, Billings, Ramsey

Pants, at the Ann Taylor stores division, what do you now do with that because there was quite a bit of R&D that went into that I suspect to improve the pant fit, so when should we start to see kind of a redesign of that in the stores.

Kay Krill

Well its really not going to be a redesign. We have not gotten negative feedback about the fit, [blocks] itself, what I was referencing was the fact that we didn’t have many leg shapes to offer. We were all basically a boot leg pant shop in the Ann Taylor division. We missed the skinny leg trend in that division and we also had some opportunity with pockets, to remove pockets, which we have done going into 2010.

So it was more very addressable issues such as pockets and leg shapes that we needed to get on top of and we have so going into 2010 we’ve corrected that. The fit blocks themselves, we’ve gotten positive feedback on. I think it was our choices that we offered.

Operator

Your next question comes from the line of Michelle Tan – Goldman Sachs

Michelle Tan – Goldman Sachs

My question was on gross margin, you were pretty close to peaks this quarter, I think within a matter of less then 100 basis points from your prior peak, I was wondering how much of that rate do you think is sustainable because of the process improvements you’ve made and how much of it is because the inventory position was perhaps too clean and you were sales constrained. So how much of it would you expect to have to give back, if at all.

Mike Nicholson

I’d say that we were clearly constrained from an inventory perspective and so the impact of that strategy clearly did have a dramatic impact on our ability to drive this year on year rate improvement but I will say that a fairly sizable portion of the overall margin increase was attributable to improvement in IMU within the business across all of our brands and channels.

Michelle Tan – Goldman Sachs

And then so, would you expect the rate next year to be somewhat lower assuming that sales are positive and you’re driving a healthier top line business—

Mike Nicholson

I think its reasonable to assume in 2010 that a rate that exceeds 57% could be a bit of stretch. We are clearly going to have put inventory behind the business. So we’re going to be focused on driving the top line as we head into 2010 and we will be willing to give a bit of rate in order to drive top line and incremental gross margin dollars.

Kay Krill

And I’ll just tack in that we’re definitely projecting and buying our inventories for positive comp performance across both brands and all channels for 2010.

Operator

Your next question comes from the line of Neely Tamminga - Piper Jaffray

Neely Tamminga - Piper Jaffray

Just wanted to ask a little bit more on gross margin here, so if I take a long-term view of your gross margin rates by quarter this whole year you’ve been tracking about 200 basis points higher then your longer-term trend ex last year, is that something similar that trend can hold into Q4 and I guess related to that can you size up how your markdown rate, maybe not giving the rate, but just quantify where your markdown rate in Q4 was last year relative to Q3.

Mike Nicholson

What I’d say in terms of the fourth quarter, here’s how we’re thinking about it today. As Kay mentioned during her comments we are anticipating a fairly significant level of promotional activity in the marketplace and that’s really reflected in our rate. In terms of how we’re thinking about the rate specifically, we’re thinking about a rate inclusive of this level of promotional activity that is at or slightly above 50%.

I think longer-term in terms of your comments regarding the improvement to the historical trend, I think its reasonable to assume that we can do better then what we’ve done historically and begin to approach on a consistent basis, a rate that’s in the range of the mid 50’s.

Operator

Your next question comes from the line of Tracy Kogan - Credit Suisse

Tracy Kogan - Credit Suisse

You mentioned positive comps for next year and I was just wondering how we should think about expenses next year. I know you have $25 million from the restructuring savings coming in but what level of expenses need to go back into the business if any, as your sales pick up.

Mike Nicholson

A couple of comments, we’ll clearly provide you with more specific guidance in terms of the overall level of SG&A spend and rate in March, 2010. But what I will say is we’ve provided you a perspective on SG&A for the fourth quarter. I think you have good visibility in terms of the stores that will come out of the chain at the end of the fourth quarter and you have a perspective on the total number of stores that will come out 2010 and you should also assume that those 2010 store closures have a similar cadence to what we’ve experienced in 2009.

So I think with those assumptions and that data as well as $25 million of incremental SG&A save that we plan to drive from the restructuring program, that will provide you with a solid perspective on how you should think about it going into 2010.

What I’d say is though the incremental marketing spend that we executed in the third quarter and that we will continue to execute in the fourth quarter, you should assume in the first half of next year that we will continue to invest behind both brands and both businesses.

Operator

Your next question comes from the line of Laura Champine - Cowen & Company

Laura Champine - Cowen & Company

Just a quick housekeeping, you did mention that the massive improvement in comp trends at both brands during the quarter but I don’t have the months from the year previous, were you lapping a massive decline intra quarter because I know that things were falling apart this time last year and then just secondly, with the gross margin so much better and the sales significantly worse then what we were looking for coming into this, did you cancel a promotion or change strategy in the middle of the quarter that led to those different results.

Mike Nicholson

I’ll take the comp question, in terms of lapping some sort of massive or significant change in trends last year, there were a couple of points on each side of the quarter but nothing significant that we were anniversarying and then just in terms of the overall performance with respect to rate in the quarter, to the best of my knowledge, there was really no cancellation of any promotional activity.

It was really truly a function of the position, inventory position going into the quarter as well as very thoughtful strategic promotional activities that were executed across both businesses.

Operator

Your next question comes from the line of Roxanne Meyer - UBS

Roxanne Meyer - UBS

First question is on LOFT, obviously it sounds like you wish you had a little bit more inventory even heading into the fourth quarter to support some of your holiday offering, when do you expect to get back into better position and I guess what categories are you able to chase versus not able to chase at this point.

Kay Krill

First of all, we’re definitely light in LOFT and in the e-commerce and factory channels based on their sales run rate. So I think the fourth quarter its fair to say that we are light pretty much throughout the third quarter but we feel comfortable that we can have these targeted category promotions to really keep the traffic going and get our share.

Going into 2010 as I said previously, we have planned, projected and purchased our inventories to have positive comp performance in the LOFT business so we feel like heading into the first quarter we’ll be in much better shape.

We were extremely light last year in LOFT specifically in the month of February so we feel much better about their inventory positioning as we head into February this year.

Roxanne Meyer - UBS

And then as it relates to your store closing program, are you able to share with us at this time what percent of the store closings whether its for the end of this year or for the big group that’s expected at the end of next year that are unprofitable that will end up being an accretive impact to your P&L.

Mike Nicholson

Its safe to assume that although there’s a pretty sizable amount of volume that comes out of the business there is little to no impact on the bottom line so from where I sit there’s actually, we haven’t quantified for you but there is an incremental benefit to operating profit and clearly a benefit to cash flow for the corporation, both cash flow in terms of operations of the store as well as working capital that will come out due to the inventory reduction.

Roxanne Meyer - UBS

And then I’m just wondering as it relates to your comps for the quarter are you able to provide the individual comp metrics between, breakdown between AUR and transaction.

Mike Nicholson

No we don’t disclose that level of detail.

Operator

Your next question comes from the line of Stacy Pak – SP Research

Stacy Pak – SP Research

Couple of things, first just clarifying what you said on the comps, am I wrong, I thought there was a significant difference between the start of Q3 and the end. Like I had LOFT at negative two going to negative 20 and I had stores at negative 12 going to negative 30, so I guess the question is was there an improvement in and to your run rate from August to October in the brands and does that align with the comp guidance that you just gave for Q4. Also on the sales for Q4, the total sales, is there something else going on there that they should be below Q3 or is that just the closures. So if you could comment a little bit more there by brand. And then I’m hoping you can talk some more about pricing and how to offer value and whether and when we’ll see a shift more in your emphasis to drive comp versus margin. It sounded like we would see that for 2010 but I’m just kind of wondering how you’re thinking about all those things.

Mike Nicholson

I’ll take a stab at the first question regarding comps, while I don’t fully recognize the comp data that you’re quoting, what I will say is that there was a progressive improvement in the two year run rate over the course of the quarter and that we expect that that improvement will continue as we move through month by month throughout the fourth quarter and that is essentially what is reflected in our comp guidance.

Kay Krill

Let me just comment a little bit about pricing, I think that especially in Ann Taylor division one of the learnings coming out of the third quarter is we did not have enough breadth of assortment available at opening price points and select categories of the business. So during the quarter we had to course correct by providing incentives to be more competitive where necessary.

And those were very targeted categories that we had to do that. On the other hand, we did raise prices in jewelry and shoes in the Ann Taylor division and those sold through at full price so despite raising the average ticket in those categories, that business was very strong.

So our takeaway is that she’s definitely going to pay for product that’s a fashion want and demonstrates high quality and value however, we do think that especially as we build our assortment going into 2010 that we need to infuse more opening price points in select categories in that division.

As far as LOFT goes, we feel, we did not change pricing strategy at all and we have been category promoting certain categories that we had planned to throughout the quarter and I think represent tremendous value. So I would say initial prices are more of a concern at Ann Taylor but we have addressed that and corrected that.

And like I said, going into 2010 we have purchased inventories in both brands and all channels to have positive comp performance.

Stacy Pak – SP Research

And then just following up just so I understand the run rate, so the run rate that you’re guiding to in Q4 is consistent with what you achieved in October or it implies an improvement and then can you just comment on the total sales.

Mike Nicholson

So a couple of things, let me reiterate what I said, in terms of improvement in two year performance, month over month throughout the third quarter that’s what we experienced and our comp outlook reflects a continued improvement in the two year run rate month over month throughout the fourth quarter.

In terms of our outlook with respect to total fourth quarter sales, and our perspective that total sales will be slightly below the levels achieved in the third quarter, I think about that in the range of say 2% to 3% and when you account for the perspective that we provided in terms of Ann being down low to mid teens, LOFT flat to slightly positive and you mix that out, you will result in a total sales change that will be a couple of points below our actual performance on a total company basis, in the fourth quarter over the third quarter.

Operator

Your next question comes from the line of Jennifer Black - Jennifer Black & Associates

Jennifer Black - Jennifer Black & Associates

I wondered if you quantified, you may have already said this, of the 850 basis points of expansion in the margin, how much was merchandising and how much was sourcing and then I also wondered if you can tell [if] the sales at the Ann Taylor division, how many of your customers or what percent are returning customers or [last] customers.

Kay Krill

I would say the gross margin definitely is really based on merchandising and really smart promotional activities in order to drive the margin and obviously coming into the quarter in a very very clean position, because we really did not have much of an inventory clearance stance for the third quarter. It was more category promotion.

So that’s what I would say about margin, it really was about merchandising. And then you’re second question was—

Mike Nicholson

---related to IMU benefits and we haven’t specifically quantified the IMU sourcing savings but what I will say is that it was clearly a contributing factor.

Kay Krill

And what was your next question.

Jennifer Black - Jennifer Black & Associates

Well I just had one more follow-up, it was about the last customers returning to the brands, can you tell as far as specifically Ann Taylor and then I wondered also with you loyalty program in place, are you finding she’s utilizing the Ann card now when she’s coming back.

Kay Krill

We definitely have seen an uptick in the credit card applications for sure this quarter, I’ll say that. And then the second thing, is that we had a client, external client panel, most recently and I will tell you that over 80% of the clients responded favorably to the new Ann and the ones that did not, really cited they wanted more sale and they wanted more wardrobe essentials in their size.

So that was, that’s all I can tell you at this point. We are doing ongoing research and I will be updating you as we go along but I would say it was favorable.

Operator

Your next question comes from the line of Lorraine Hutchinson - Bank of America

Lorraine Hutchinson - Bank of America

I was just hoping for an update on the outlook strategy both at Ann and LOFT, it sounds like things have started to improve this quarter and I guess just curious about your expansion plans going forward in light of that performance.

Kay Krill

We are really pleased with the factory performance this quarter as well as LOFT Outlet and at this point we are not going to give you our store opening strategy until next March, but I will say that we were very happy with their performance in the quarter, in both of them.

Lorraine Hutchinson - Bank of America

And will you be buying inventory for positive outlook comps.

Kay Krill

Absolutely, absolutely and we were also very short in inventory as we head into the fourth quarter in those businesses as well, in both Ann Taylor and LOFT Outlet. So we are, as I said earlier going into 2010 we are definitely projecting and buying inventories for positive comps across every brand and every channel.

Mike Nicholson

In fact, we actually did see that channel of distribution turn to a positive comp in October and we fully expect that channel to comp positive in the fourth quarter as well.

Operator

Your next question comes from the line of Kimberly Greenberger - Citigroup

Kimberly Greenberger - Citigroup

It sounded like you are preparing to build inventory, we just wanted to know what gave you the confidence that it was the right decision at this time and if you could share with us how we should think about inventory at year end on a per square foot basis and then the first half of 2010.

Mike Nicholson

What I’d say is consistently across both brands, all channels, we are seeing traction in the business and we are seeing an improvement in the overall store performance. In terms of our year end inventory position on a total dollar basis from where I sit today, I see a dollar decline that’s in the range of the mid single-digit negatives, but to Kay’s point as we begin to transition our way into Q1, I would expect to see a bit of a build off that year end position.

Operator

Your next question comes from the line of Jeff Black - Barclays Capital

Jeff Black - Barclays Capital

Can you talk about leverage and let’s say we get back to some kind of mid single-digit negative comp at some point in the future, you were running 44, 45’s back in 2007 on that number and we’re sitting here at 53 and change I think to end the year, if that’s correct. What kind of expense rate do you think you’d be running at a negative mid single-digit comp.

Mike Nicholson

What I’d say is looking back in terms of the third quarter I would have been able to hold my rate and slightly leverage on a negative five comp. In terms of looking forward, I’m not in a position to share that today.

Kay Krill

And just to pipe in, you said going forward negative comp performance into 2010, if I heard you correctly, and I’ve said that we are planning and buying for a positive comp performance in both brands in all channels for 2010, not negative.

Jeff Black - Barclays Capital

I clearly heard that, I’m just staying conservative and wondering what the potential was there. And to follow-up on IMU, do we see that benefit continue and get better in 4Q and then into the first half of next year.

Mike Nicholson

What I’d say is I would assume that we will continue to be able to continue to secure a similar level of IMU benefit if you will as we move through the fourth quarter and into the first half of 2010. When we move to the second half, we’ll obviously begin to anniversary the activities and the benefits that we realized in the back half of 2009.

With that said, as we sit here today, Kay and I are very pleased with the progress that Paula and her worldwide sourcing and logistics team have made here in New York and the Far East and in Louisville, but I think we also have to be somewhat realistic with respect to some headwinds we face with respect to currency as well as capacity that comes out the supply chain.

However we’re very confident that Paula and her team will be able to continue to drive cost reduction and efficiency moving forward.

Operator

Your final question comes from the line of Janet Kloppenburg - JJK Research

Janet Kloppenburg - JJK Research

A couple of questions, I was confused about the question about LOFT’s comps, I think I heard they might have been positive in October and more positive in November, but I don’t want to misconstrue something that may not be true. I was also wondering if you could tell me if there was a bonus accrual reversal last year or just a bonus reversal last year in the fourth quarter so that my SG&A number is correct. And then I was just wondering, for me it would be really helpful given that this was the first season of the repositioning of the Ann Taylor brand, if you could talk a little bit about the strengths and how you’ll build on those and on what you might have viewed as the weaknesses and how you’ll cope with that in the first quarter and going forward.

Mike Nicholson

I’ll start, the first question regarding LOFT comp in 2009 October, no we did not say that LOFT comped positive in October, but we did say as we move into the fourth quarter that we fully expect LOFT to be in the range of flat to slightly positive.

In terms of bonus accrual our third quarter 2009 results reflect bonus accrual or bonus expense as does our outlook for the fourth quarter and we are up against a third quarter prior year period where SG&A did benefit from a bonus accrual reversal and the fourth quarter SG&A results included no bonus accrual expense.

Kay Krill

Let me pipe in with your last question, I think that I would tell you that there’s three things that come to mind, first as I said earlier, we need to add more opening price points in select categories because I think that the business would have been healthier had we had those opening price points in key categories.

Second of all, we needed more color. We definitely needed more color in tops and I’m sure you would agree with that. That’s something that we’ve already addressed and really is evidenced in the newest store set, November definitely has more color and we will have more color throughout the fourth quarter and into 2010.

And third, and really important is that we needed more style breadth across certain categories that we were too narrow in our SKU’s and we have definitely addressed that going into 2010. All of these issues are really addressable and we’re on top of all of them.

Operator

That was our final question. We thank you for your participation in today’s call.

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Source: Ann Taylor Stores Corporation Q3 2009 Earnings Call Transcript
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