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dELiA*s, Inc. (NASDAQ:DLIA)

Q3 2009 Earnings Call

November 24, 2008 10:00 am ET

Executives

Marc G. Schuback – Vice President, General Counsel & Secretary

Robert E. Bernard – Chief Executive Officer & Director

Walter Killough – Chief Operating Officer & Director

Michele Donnan Martin – President dELIA*S Brand

David J. Dick – Chief Financial Officer & Treasurer

Analysts

Samantha Panella – Raymond James

Welcome to the dELIA*S Incorporated third quarter 2009 earnings conference call. At this time all participants are in a listen only mode. Later, we will open the lines to conduct a question and answer session and instructions will follow at that time. (Operator Instructions) As a reminder ladies and gentlemen, this conference is being recorded on November 24, 2009 and may not be reproduced in whole or in part without permission from the company. Today’s conference call will be available for replay beginning at 2 pm today through 11:59 pm December 22, 2009 on dial in 888-286-8010 domestic or 617-801-6888 international. The pass code is 26361106.

I would now like to introduce Mr. Marc Schuback, Vice President, General Counsel and Secretary of dELIA*S Incorporated.

Marc G. Schuback

If you need a copy of our third quarter press release, it is available on our website www.DeliasInc.com. Before we continue, let me remind you that our statements today regarding the company’s future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Private Securities Litigation Reform Act of 1995. These forward-looking statements which can be identified by the use of the words believes, expects, should, estimate, plan, project, anticipate or similar expressions are based on managements’ current knowledge and assumptions about future events.

Forward-looking information and statements involve risks, assumptions and uncertainties that could actual results to differ materially from our expectations as a result of many factors including those contained in our annual report on Form 10K as well as in our subsequent filings with the SEC. These filings are available on both the SEC and dELIA*S websites. All forward-looking information and statements are made as of the date of this call and we disclaim any intent or obligation to update them.

As a reminder, this call is being recorded on November 24, 2009. At this point I would like to introduce our Chief Executive Officer Rob Bernard.

Robert E. Bernard

Thank you for joining us for the dELIA*S Inc. third quarter earnings call. With me today are Walter Killough, our Chief Operating Officer; Michele Donnan Martin, President of dELIA*S Brand; and David Dick, CFO. I’ll begin by providing an overview of our performance for the third quarter as well as some recent trends. I’ll then turn the call over to Dave for a detailed review of our financial results. After Dave provides this review I’ll be back to discuss our outlook and strategic direction. Following our prepared remarks Walter, Michele, Dave and I will be available to answer your questions.

During the third quarter we delivered improved operating results in line with trends we’ve experienced over the course of the year. We were again able to control costs, reduce inventory levels and preserve cash. As we have previously discussed, we’re seeing larger peaks and valleys and trends of consumer demand with need based buying patterns. We experienced flat comparables to our sales with improved margins during the years August and September back-to-school period. This continues the highly successful 2008 back-to-school selling season during which we experienced mid teen comparable store sales growth. In our direct business we experienced mid single digit growth for the August and September time period primarily driven by a strong sales increase in [Alloy] partially offset by some softness in dELIA*S direct.

Key financial highlights for the third quarter included a 5% increase in total revenue, continued improvement in retail merchandise margins, improved inventory management leading to direct inventory being on plan and lower than last year, positive EBITDA for the quarter compared with the loss from the prior year, a 43% improvement in operating loss and a cash balance greater than $42 million at quarter end. These results would have been significantly stronger if sales trends for retail and direct had not turned negative in the month of October and accelerated during the last two weeks of the month during which we experienced double digit declines.

I’d like to now turn to a review of the segment starting first with retail. Total revenue for the retail segment increased 8% over the prior year driven by store growth and tempered by a 3.6% decline in comparable store sales for the quarter. Due to our ongoing success in indigo denim in recent quarters, we broadened our assortment in this category for the 2009 back-to-school season and carried higher inventory levels. We’re please we experienced a double digit positive sales trend in this expanded category during the back-to-school selling season.

Conversely, sales of colored bottoms were considerably lower than they were during last year’s back-to-school period when our depth and breadth of inventory was a point of differentiation for our brand. For the back-to-school time period we were able to deliver a positive comp in bottoms despite the weakness in color. In tops we reduced our sweater style count inventory compared to last year and instead made inventory in style count investments in plaid and woven shirts resulting in a positive comp. In our cut-and-sew logo top business we saw weakness during back-to-school that intensified during the month of October. The overall top business comp’d negatively due to the softness in cut-and-sew and logos.

In summary, our merchandise moves and inventory investments yielded a flat overall comp for the retail segment during the core back-to-school period and a single digit negative comp in early October. Also during the third quarter we continued to closely manage expenses and leveraged our reduced overhead costs in the retail segment. We ended the third quarter with lower average units per store despite the planned expansion of the denim category and a solid inventory position that was in line with our plans. Due to increased sales improved merchandise margin as well as reduced expenses, we reduced our retail segment operating loss for the third quarter by half to $1.2 million to $2.4 million in the prior year period.

For the direct segment we experienced a slightly increase in revenue. While full price selling improved during the August and September back-to-school selling period versus the same period last year these trends began to reverse towards the end of the peak weeks. We saw increased productivity in full priced books in our Alloy business and decreased productivity in our dELIA*S direct business. We’ve been able to improve our performance in Alloy by developing a strong tops business that includes sweaters and promotional knits as well as by driving solid performance in our denim business supported by a $29.90 price point.

In our dELIA*S direct business where sweaters are a larger percentage of total business as compared to retail stores, the combination of woven shirts and sweaters comp’d negatively versus last year. In addition, while last year the colored denim trend was a major driver of the bottoms business in direct, the negative trends in color this year more than offset the positive momentum in our indigo denim business.

Unlike retail, the combination of the woven shirts, sweaters and colored bottom categories led to negative sales trends in the dELIA*S direct business. On a positive note we were able to drive down our inventories to levels below the prior year through a successful clearance strategy which increased sales. Largely as a result of reduced overhead expenses, we reduced our operating loss for the direct segment by 32% to $700,000 from $1 million in the third quarter of the prior year.

I’ll update you more on our expectations for the fourth quarter and strategic direction after Dave provides a more detailed review of our financial performance. At this time I’d like to turn the call over to him.

DD

I will start today by reviewing our third quarter 2009 results and then I’ll provide an update on our expectations for fiscal 2009. All of the results discussed today will be for continuing operations only unless we state otherwise. Net loss for the third quarter of 2009 was $1.3 million or $0.04 per diluted share compared to net income of $.8 million or $0.03 per diluted share for the third quarter of 2008. Of note, the benefit for income taxes for the third quarter of 2009 was $.7 million compared to a benefit for income taxes of $4.4 million for the prior year period.

Income from discontinued operations for the third quarter of 2008 was $2.7 million. Total revenue for the third quarter of fiscal 2009 increased 4.9% to $59.7 million from $56.9 million in the third quarter of fiscal 2008. Revenue from the retail segment comprised 59% of total revenue and revenue from the direct segment comprised 41% of total revenue. This compares to 57.2% in retail revenue and 42.8% in direct revenue in the prior year quarter.

Total gross margin for the third quarter of 2009 was 36.5% compared to 37% in the prior year quarter reflecting increased clearance sales in the direct segment partially offset by improved inventory management. SG&A expenses were $23.7 million or 39.6% of sales in the third quarter 2009 compared to $23.8 million or 41.9% of sales in the prior year third quarter. The improvement in SG&A expenses as a percent of sales was largely due to reduced overhead costs in both segments as a result of our restructuring. We are on track to exceed our targeted $6.8 million in annualized cost savings and will continue to look for additional opportunities to reduce costs as we move forward.

As Rob mentioned, we delivered positive EBTIDA during fiscal 2009 versus a loss in last year’s third quarter. I will now briefly highlight our results by segment. Total revenue for the retail segment for the third quarter of fiscal 2009 increased 8.2% to $35.2 million from $32.6 million in the third quarter of fiscal 2008. Retail comparable store sales decreased 3.6% for the third quarter compared to an increase of 7.6% for the third quarter of fiscal 2008. Gross margin for the retail segment which includes distribution, occupancy and merchandising costs was 30.9% compared to 30% in the prior year period. Retail segment gross margin was driven by an increase of merchandise margin and improved inventory management.

SG&A expenses for the retail segment were $12.1 million or 34.4% of sales compared to $11.6 million or 35.5% of sales in the third quarter of 2008. The improvement in SG&A as a percent of sales reflects the leveraging of reduced overhead costs. The operating loss for the third quarter for the retail segment improved to $1.2 million from $2.4 million in the prior year period.

We opened four store locations during the third quarter of fiscal 2009 ending the period with 108 stores. We have opened two stores in the early part of the fourth quarter including one relocation and our current store count stands at 109. We will not have any additional openings in fiscal 2009.

As for the direct segment, for the third quarter of fiscal 2009 total revenue increased .5% to $24.5 million from $24.4 million in the prior year period. Gross margin for the direct segment was 44.5% compared to 46.3% in the third quarter of the prior year. The decline was due to decreased clearance sales versus full price selling. SG&A expenses for the direct segment improved to $11.6 million or 47.2% of sales compared to $12.3 million or 50.3% of sales in the prior year period. The improvement in SG&A as a percentage of sales was primarily due to the restructuring we completed that allowed us to reduce overhead expenses and improve efficiencies.

The operating loss for the third quarter for the direct segment improved to $.7 million from $1 million in the prior year period. For the first nine months of fiscal 2009, total revenue increased 6.2% to $157.6 million from $148.4 million in the prior year period. Total gross margin was 34% compared with 34.9% for the prior year period. SG&A expenses were $67.7 million or 43% of sales compared with $69 million or 46.5% of sales for the prior year period. For the first nine months, our consolidated net loss improved to $9.6 million from $11.7 million for the first nine months of fiscal 2008.

I will now move to a discussion of the balance sheet. We continue to maintain sufficient financial flexibility and a strong balance sheet. As we have stated previously we aim to preserve cash and limit our operating expenses given the uncertain economic environment. At quarter end we had cash and cash equivalents of $42.1 million compared with $8 million in cash at the end of the third quarter of 2008. Cash at the end of this year’s third quarter includes approximately $15.8 million that is in a restricted account in accordance with our $15 million letter of credit facility with Wells Fargo that was put in place at the end of June. At quarter end we had $7.2 million in letters of credit outstanding under the LC facility.

Cash was also reduced by $2 million during the third quarter as a result of the termination payment for the mortgage on our distribution center that was made in September. Total net inventories decreased to $36.9 million at quarter end compared with $40.2 million at the end of the third quarter of the prior year. For the retail segment, inventory decreased to $20.3 million at quarter end compared with $21.2 million at the end of the third quarter last year due to more effective management.

Inventory in dollars per average store was down 19% compared to the prior year. Average units per store decreased by 14%. For the direct segment, inventories decreased to $16.6 million compared with $19 million at the end of the third quarter last year and is in line with expectations. Year-to-date cap ex was $10.3 million and compares to cash cap ex for the third quarter of fiscal 2008 of $10.8 million.

Before I turn the call back to rob, I wanted to update you on our outlook for fiscal 2009. As stated in our press release, given current sales trends we have tempered our outlook for 2009. We now expected negative EBITDA for the full year compared to our original expectations of breakeven EBTIDA. Yearend cash and cash equivalents of $45 million to $50 million including restricted cash down from our originally expected range of $50 to $55 million. Yearend inventory in retail will be current and on our plan of down single digits per average store and dollars. Yearend inventory for the direct segment will be down 15% to 20% in dollars and capital expenditures under $13 million for the year.

I’d now like to turn the call back to Rob.

Robert E. Bernard

As I mentioned earlier, while we experienced a solid back-to-school selling season cutting our operating loss 43% to a year ago, we experienced a significant decline in sales during the last two weeks of October and this has continued in November. We believe the causes of the drop offs that we are seeing are negative transactions in key merchandise categories and decreased store traffic and lower direct response rates. We’re working diligently with our team to adjust for these issues and have developed an aggressive action plan.

As you may recall, despite the intense economic down turn in the fourth quarter of 2008, we experienced only slightly negative comparable store sales during November and December time period with a positive 3% comp in December and our dELIA*S direct business grew in the high single digits. The drivers of last year’s performance were colored bottoms, both denim and especially cords as well as our promotional sweater and logo business.

So far in this year’s fourth quarter we’ve found that these categories are comping negatively to last year’s rates. The slowdown in colored bottoms that we experienced during back-to-school as continued in to holidays especially our corduroy business. Unlike during back-to-school where we were able to drive positive comps in bottoms through our indigo business, we’re experiencing a negative comp in bottoms since indigo is not as large of the business in November. While we’re pleased that our woven business and flannel and plaids is strong and trending close to plan, our sweaters are not performing as well and have a greater negative comp trend than we expected.

The weakness in the sweater business has impacted both channels but the effect to our direct business is more significant because sweaters are a larger proportion of the mix. While our cut-and-sew business is extremely strong compared to last year, our logo business has continued the negative comp trend October. The overall result is a negative comp in the stores and a decreased conversion rate in the direct business.

In response to these shifts in merchandise trends we’re aggressively managing our inventory in the fourth quarter and are addressing our sales misses with accelerated promotional activity. In the stores we’ve tested some new promotional strategies that seem to be improving our cost trends. In the direct business we’re planning to leverage our email database to drive sales through additional promotions. In some categories such as logos we’ve been able to react quickly to change content in time for the holiday season.

Looking at our store productivity, even though we don’t have year-over-year traffic data from [Ucobian] software, we believe our store traffic is down since sales have turned negative despite our conversion rates being up from October. We’re therefore going to concentrate on the following strategic initiatives. First, is a strategic change to our top business that will include a promotional strategy to drive increased transactions in our key top categories while continuing to differentiate our brand through fashion content and consistent quality. And, a sourcing strategy that continues to reduce our time to market providing the best current fashion and quality at desirable margin rates.

The number one issue facing teen sportswear brands in the mall is developing and growing the tops business which drives transactions. We went in to the fourth quarter with the strategy to maintain our breadth of promotion in tops aligned with last year but at slightly higher price points. However, we believe that the price points the customer will pay for cut-and-sew knits and sweaters has changed which has caused a drop in transactions for us and our competitors. As a result, we intend to refine our assortment and promotional price point. We anticipate that this redirected approach will drive conversion in both our stores and direct businesses.

The second strategic initiative we focused on is improving operational execution to drive sales productivity in our stores. We invested in the [Ucobian] software to give us insight in to our conversion by store and to tie managers on duty to the conversion. As expected, this has been an eye opener for us. We see differences in the conversion rates by store that vary greatly. Through the [Ucobian] reporting we were able to determine behaviors that drive underperformance which allows us to focus on the stores that are underperforming. We plan to focus on our poorest performing stores and conversion and believe we can bring them up to our average conversion rates. After identifying the factors that have driven the underperformance in most of these stores, we’re in the process of developing and implementing a new coaching guide to change behaviors in our underperforming stores.

We also see our denim business as a major driver of positive performance. We’ve grown this business every year over the last six years and we still believe there is significant comp growth in this category through better execution in our stores. We are therefore refining our staffing, training and operational procedures for improved execution. Finally, in order to focus on improving the productivity of our current box, we plan to scale back our stated store growth strategy of 15% a year to a high single digit percentage growth.

The majority of the projects will also be locations that will allow us to better balance the size of our districts. In addition to limiting our store growth we also anticipate that our cap ex spend less year will be less than in 2009. We are still in the process of evaluating our options and will give more specific details on our fourth quarter conference call.

In these difficult and uncertain times, we’ll continue to look at our expense lines including our catalog circulation strategy to see what savings can be achieved over and above the $6.8 million we’ve already saved. Overall, we’re confident in the approach we’re taking to increase the productivity of the current retail chain as well as our direct segment. We believe in our differentiated brand and our ability to meet the needs of our core customer through trend right affordable high quality fashion.

We want to thank all of our team for their efforts to give us a strong third quarter financial improvement in a difficult environment and we look forward to updating you on our business soon and thank you for your interest in dELIA*S. With that, I’ll now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Samantha Panella – Raymond James.

Samantha Panella – Raymond James

Any regional differences that you’re seeing in terms of the same store sales trends at the end of October early November?

Robert E. Bernard

No Sam, not specifically.

Samantha Panella – Raymond James

It does seem like we’re hearing from a lot of teen retailers sort of a similar trend. Any read that you’re getting from your customer in terms of needing an event such as back-to-school or holiday to drive the business? How has I guess these traffic trends been throughout the year up until this point?

Robert E. Bernard

Clearly, we’ve seen our traffic as we reported all year down we’re guessing double digit. We don’t have an actual traffic counter from the year before but in looking at transactions we’ve had to counter act this traffic decline in gross in average dollar sales and unit transactions which we’ve successfully done through the first three quarters with top line growth and margin improvement. In this fourth quarter we continue to see this same traffic malaise by the consumer and we went in to the fourth quarter knowing or expecting that it would again be very promotional or very competitive.

Samantha Panella – Raymond James

Did the recent trends change your thinking in terms of how you approach Black Friday and the holiday season?

Robert E. Bernard

No. We’re going to continue to be very aggressive meaning we believe that it isn’t just one day, Black Friday, the need to be very in front of your customer with value and great fashion every week of the year even more so during the key traffic weeks. But, we think the customer in today’s changed environment wants a deal every day.

Samantha Panella – Raymond James

In terms of the third quarter, what drove the merchandise margin improvement at retail and how should we be thinking about gross margin in the fourth quarter with respect to those retail and direct?

Robert E. Bernard

Well we continued through our sourcing efforts and our key sourcing partners to be able to not only improve our time to market meaning being able to buy closer to market but also being able to get better margins by working with multinational based sourcing partners now that we’re a store group of over 100 stores. So, it’s across the board in most of our categories, most everyone that we’ve seen increased margins from our sourcing efforts which gets passed on to the consumer but also translates to the bottom line. This will continue in the fourth quarter and we look to even more improvements next year.

Samantha Panella – Raymond James

I guess given the drop off last year in the fourth quarter of ’08 you have the opportunity to improve gross margin this year relative to last year?

Marc G. Schuback

Sam, what we’re looking at right now is you’re right we did have a drop off last year. We would expect based on the current promotional environment we’ll still be able to deliver relatively flat product margin on the retail side. On the direct side though, if you remember, we did not have the margin erosion in Q4 last year so there’s going to be more pressure on the direct side this year.

Samantha Panella – Raymond James

Can you just talk about your class of ’08/’09 stores relative to your older stores and how they’re performing?

Walter Killough

We still see the ’08 [inaudible] stores I think we said on the last conference call around 25% to 30% stronger in dollars per square foot.

Operator

It doesn’t appear that we have anyone in the queue at this time so I’ll go ahead and turn the call back over to management.

Robert E. Bernard

We’d like to thank everyone for participating. If there are no further questions we will pick you up after the fourth quarter. Thank you operator and thank you everyone.

Operator

Ladies and gentlemen this concludes our presentation today. Thank you so much for your participation. You may now disconnect.

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