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Coldwater Creek, Inc. (NASDAQ:CWTR)

Q3 2009 Earnings Call

November 24, 2009 5:00 pm ET

Executives

Lyn Walther - Investor Relations

Dennis Pence - President & Chief Executive Officer

Georgia Shonk-Simmons - President & Chief Merchandising Officer

Tim Martin - Chief Financial Officer

Analysts

Neely Tamminga - Piper Jaffray

Chris Kim - JP Morgan

Liz Dunn - Thomas Weisel Partners

Liz Pierce - Roth Capital Partners

Margaret Whitfield – Sterne Agee

Richard Jaffe - Stifel Nicolaus

Eric Beder – Brean Murray, Carret & Co.

Analyst for Roxanne Meyer - UBS

Operator

Welcome to the Coldwater Creek third quarter 2009 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Ms. Lyn Walther, of Coldwater Creek. Thank you, you may begin.

Lyn Walther

Good afternoon everyone and thank you for joining us as we discuss our results for the third quarter ended October 31, 2009. Participating in today’s call are Dennis Pence, Chairman and Chief Executive Officer, Georgia Shonk-Simmons, President and Chief Merchandising Officer, and Tim Martin, Chief Financial Officer. John Hayes, our newly appointed interim Chief Financial Officer is also on the call.

Before we begin I would like to remind everyone that the statements contained in this conference call that are not historical facts, constitute forward-looking statements within the meaning of the securities laws. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. These risks and uncertainties are described in the company’s filings with the Securities and Exchange Commission. No one should assume later in the quarter that the comments we provide today are still valid. Moreover, we are not undertaking any obligation to provide updates in the future.

In addition, during this call we will be providing certain non-GAAP financial measures. The most directly comparable GAAP financial measures and information reconciling these Non-GAAP financial measures to our GAAP results are included at the end of our third quarter earnings release issued earlier today which has been posted on our website.

Now, I would like to turn the call over to Dennis Pence.

Dennis Pence

Thanks Lyn. It is a pleasure for me to be addressing you today. Some of you I have known for many years and for those of you who I don’t know I look forward to meeting you in the near future. I would like to begin by reviewing the current quarter and then I will discuss the areas we will focus on to improve our performance and the steps we will take to position Coldwater Creek for long-term success.

Net sales for the third quarter came in above expectations increasing 17% to $267 million. Our renewed marketing efforts in terms of increased catalog circulation and a return to national magazine advertising drove a 5.6% increase in traffic and our compelling assortment led to a 560 basis point increase in our conversion rate resulting in a 14% same store sales increase for the quarter. However, our strong top line results came at the expense of gross margin and increased sales and marketing expenditures.

Last year Coldwater Creek was focused on reducing promotional levels and driving full price sales. However, we moved away from this strategy late last year in response to the challenging economic environment. In addition, we also expanded our value pricing initiatives while at the same time continuing to offer more promotional discounts as well as our traditional October sale event.

While this strategy was successful at driving traffic and sales the combination of substantial value pricing, discounting through promotions and an unsuccessful October sale led to more significant margin deterioration than we had originally anticipated. Overall, our promotional strategy was too aggressive as our product was on trend and resonated well with our customers.

Going forward we are taking steps to address our margins by adjusting our value price strategy, fine tuning our discounting cadence and modifying our approach to our quarterly sale event. We still believe value plays an important role in our customer’s purchase decision especially in today’s economy and we will continue to offer value as one component to our assortment.

However, our customers are also more focused on fashion and differentiation and we have seen we can effectively sell products across a range of price points when the fashion is right. As a result, we are making adjustments to our product pricing which we believe will allow us to have a better balance of fashion and value in our assortments and we will begin to realize the benefits of these efforts with our spring collection.

In addition to balancing pricing across our assortments we will also modify our promotional cadence. We recognize that in this environment offering discounts is effective at driving traffic. We will continue to offer promotions to our customers through our catalogs and email campaigns but we will adjust the magnitude and timeliness of these offers. Furthermore, we will reduce the usage of promotional offers in national magazine ads and instead focus these efforts on brand building.

In terms of our approaches to sales, we found that during our quarterly sale our customers did not respond to sales the way she has traditionally, a trend we began to experience to some extent in the first half of this year. As a result, during our October sales event we were forced to take more aggressive second mark downs to clear product, negatively impacting our margin rate.

For the fourth quarter we have made several adjustments to our clear strategy. First, we will shorten the length of our sale which has typically been 4-5 weeks. Second, we will make our initial mark downs more meaningful. We believe this integrated pricing strategy will enable us to improve our margins and profitability during sale periods.

As I look at Coldwater Creek today I see a brand with tremendous opportunity. We have a strong and engaged customer base that has been carefully built over the last 25 years. We pride ourselves on offering an exceptional customer experience in our stores and we are continually finding ways to improve the quality of our experience. In this regard we were recently once again recognized by the National Retail Federation as one of the top 10 retailers in the United States for customer service.

For a number of years we experienced tremendous growth and success driven by our unique understanding of our customer’s needs and by offering compelling merchandise assortments. The past two years have been full of challenges for Coldwater Creek and we are not proud of our results. We are now intensely focused on returning Coldwater Creek to profitability and growth. To do this we need to improve our margin rates, refine our merchandising and promotional strategies and restore our direct business.

The positive response we received to our fall assortment confirms that our merchandising initiatives are on the right track. We are in the process of making adjustments to value pricing both in terms of depth and breadth of promotions. Our second priority is to refine our merchandising strategies. The heritage in the Coldwater Creek brand is an offering an eclectic assortment of apparel, jewelry and home accessories which provide the customer a sense of discovery when she shops our stores.

To restore the unique store experience we plan to refine and improve our home accessory and jewelry businesses which have been key differentiators relative to our competition. Our customer looks to us for distinctive pieces she cannot find anywhere else such as novelty jackets or an embellished sweater and our store size enables us to cater to a wide range of fashion sensibilities and looks.

Our merchant team under the direction of Georgia will now have a single point of direction and focus our merchandise on the core Coldwater Creek customer. I have had a long and successful business relationship with Georgia and I have complete confidence in her and her team. My focus will be on returning the business to sustained profitability and growth and will have full and complete control of the merchandising direction.

Our third initiative is to restore the direct business. We have seen our direct to consumer sales deteriorate significantly over the past two years. We know that part of the deterioration can be attributed to a reduction in catalog mailings in response to the uncertain economic environment. We believe we have the opportunity to regain the share we have lost by selectively increasing our catalog distribution.

In the third quarter with our increased catalog circulation, we saw a significant increase in reactivated customers as well as an increase in our new customer acquisition rate. We will also better utilize our multi-channel platform to drive retail sales as our catalogs remain our number driver of traffic to our stores.

We are enhancing the effectiveness of our internet marketing with one-to-one marketing initiatives. We are working to personalize our messaging to make the experience relevant to each customer, whether it is in reaction to a recent purchase or to a return so that we can better service her needs. Our initial focus has been on email marketing where approximately 40% of our emails are event triggered or personalized in some way. We will continue to increase the level of personalization in our emails as well as expand our efforts to other customer touch points like our website and call centers.

Our customer loyalty program continues to generate strong results as we have found that our One Creek members shop more frequently and spend on average 20% more than other customers.

As we position the company for improved performance and future growth we recognize we have to evolve our business to be profitable in this environment. We are analyzing our promotional cadence to determine the appropriate level of promotional activity to stimulate traffic while also delivering solid bottom line results. We are moving very quickly to take steps to correct our margin issues both in terms of our value pricing initiatives as well as our clearance strategies. We will continue to refine our merchandising strategies to offer our customers the unique experience she has come to expect from us and we will work to regain the market share we have lost in the direct business through effective marketing and catalog distribution.

Once we have seen this occur we believe there is an opportunity to return to growing our store base. Now I would like to turn the call over to Georgia to discuss our merchandise in more detail.

Georgia Shonk-Simmons

Thank you Dennis. Good afternoon everyone. We were very pleased with the response to our fall assortment which was the first collection that reflected our improved fit and enhanced fashion sensibility at a compelling value.

We introduced new fabrics and silhouettes which were well received by our customers. While the strength of our novelty jackets and knits demonstrated that our customers will pay higher prices for unique and fashion right assortments, we recognize we were too aggressive with our value pricing and are working to refine our pricing strategy to improve margins.

Let me begin by reviewing some of the highlights from our fall collection. For fall we focused on four key fashion trends; constructed knits, short over long, [inaudible] menswear and denim. We offered a variety of ways to interpret these trends to fit our customer’s diverse lifestyle. We are continuing to see our layering pieces resonate well with her as it provides a way to update her wardrobe without purchasing a completely new outfit.

Our sweater business was very strong particularly in the category of cardigans as we have found she is using cardigans as an alternative to jackets. That being said, our jacket and vest categories performed above plan during the quarter especially our menswear inspired patterns and modern military looks and washed canvas.

In addition, some of our higher price point jackets with detail such as embroidery were strong sellers, proving she is willing to spend for something more unique. Our woven shirts continue to show strength. We have seen strong sell through on both our printed shaped cotton shirts and our no iron shirt category. Our novelty tees, resonating well with our customers, and we will continue to focus on building this as a business.

We are pleased with our skirt business this quarter. This is a category that we have not fully capitalized on in recent collections. We are much more prepared with our skirts for this fall. We expanded our constructed knit initiative into skirts and saw success with our classy pencil skirts in the season.

In our pant category our knit jean continues to perform very well and we are looking to add more washes, colors and silhouettes for the future. We introduced corduroy for the first time this fall and we are extremely pleased with the response to both our five pocket and whisper cords. We introduced three new denim fits, the slim leg, the fitty and the low rise which also performed.

However, we found that our over assortment in denim for the fall season did hurt us slightly. We are refining our approach to this category to ensure we have the appropriate number of styles and washes in our upcoming collection.

Improving the fit of tops and jackets was a key focus and it has been very successful. We now offer two fits; a more shaped fit which has a silhouette that fits more closely to her body and an updated classic fit. We are seeing success with both fits across all sizes. We are finding that which style fit she prefers is about her fashion orientation not her size or age. We will continue to refine these fits as we move forward.

While both our shapes and classic woven no iron shirts were strong sellers, our blouse business was a disappointment for fall. Because she views us as a more casual brand our dressier blouses and ruffles did no resonate. Going forward we will take the lead from our customer and what she wants from us in this category.

The response to our value pricing initiative was strong. However, we are adjusting our pricing and promotional levels quickly. We continue to believe that value plays an important part in her decision making and we will offer her a value component to our assortment but not to the extent we had for fall. We are refining our approach by adding a tiered pricing strategy that offers opening, mid level and higher priced products with a more novel and unique merchandise.

Now let me turn to our holiday collection. Our first holiday delivery arrived in stores the last week of October. This collection was largely an extension of fall with our focus on short over long constructed knits and denim. As we find our customers use November as a month to buy for herself and update her wardrobe for the holiday season.

We also added a company sportswear line of tops, pull overs and coordinating bottoms which are made of micro fleece. We understand she wants comfortable every day wear she can wear to the store and run errands in but look totally put together. We believe this will be a great addition to our customer’s wardrobe during the busy holiday season and beyond.

This past weekend we rolled out our second holiday delivery with focuses on gift giving. December is a time that she is shopping for others and we have expanded our home accessory category to offer her great gifting options. We have worked to make our gifting more coordinated with our apparel. Sweaters and vests are always popular gift items and in our stores we have merchandised them with coordinating scarves, hats, jewelry and pins. These small additions are inexpensive ways to make the gift more exciting and thoughtful.

We have also focused more on our home accessory assortment for holiday, offering her unique and creative product for her home is an area that differentiates us from our peers. We are looking to capitalize on this both in holiday and into the next year.

As we look forward to 2010 based on the acceptance of our fall assortment we will continue with this merchandise direction. We will continue to offer her flattering and comfortable fits with new appropriate fashion looks. In addition, as Dennis discussed, we see meaningful opportunities to improve our margins by refining our pricing strategy particularly with our jackets, sweaters and pants.

We have found the quality in our merchandise when it is evident, whether it is unique detail, fit or fabrication, she is responding. In fact, some of our higher priced jackets sold as well as the ones we offered at the opening price points. We are also taking advantage of our long standing relationship with our vendors to ensure going forward we will be able to offer compelling value while also achieving appropriate margins.

In summary, we are pleased with our merchandise direction. We saw great customer response to fall and we are confident in our ability to continue to deliver a well balanced, unique and fashionable assortment that is distinctive to our brand. I look forward to updating you on our progress on the next call.

With that I will turn the call over to Tim.

Tim Martin

Thanks Georgia. Before I review our results this afternoon I would like to review the non-operational charges taken during the quarter. These costs related to a $3.8 million after-tax or $0.04 per share charge related to the CEO management change that was announced in September. Of the total $1.2 million is reflected in our SG&A as cash severance; $1.4 million is a non-cash stock based compensation charge and $1.2 million is a non-cash accounting charge for the write off of certain deferred costs related to our supplemental executive retirement plan.

In addition, we reported a $26.3 million non-cash income tax charge or $0.29 per share related to a valuation allowance against net deferred tax assets. Due to our cumulative three-year historical losses, GAAP requires us to record a valuation allowance to reduce our deferred tax assets. The recording of a valuation allowance is a non-cash book charge. We will still be able to utilize our deferred tax assets when we generate taxable income in future periods. This will have an effect of reducing our effective future tax rate until we have fully realized our written down deferred tax assets. Excluding these one-time charges our adjusted net loss was $3.9 million or $0.04 per share in the third quarter of 2009.

Now for a review of the quarter. Consolidated net sales in the third quarter increased 16.7% to $266.7 million from $228.5 million in the third quarter of 2008. This was the result of a positive comparable store sales and improved sales in the direct channel. Net sales in the retail segment which includes our premium retail stores, our outlet stores and day spa locations increased 18% to $207.3 million compared to $175.4 million in the third quarter of 2008.

Retail segment net sales represented 78% of total net sales in the third quarter compared to 77% in the third quarter of last year. We opened one new premium retail store during the quarter for a total of 356 premium retail stores in operation at the end of the period which compared to 341 stores at the end of the third quarter last year. Comparable store sales increased 14.4% for the third quarter compared to a 20.5% decline in the prior year period.

Our positive same store sales were driven by an increase in premium comp store traffic of 5.6% and an increase of premium comp store conversion rate of approximately 560 basis points. This was offset by an 11.5% decline in our average transaction value.

Direct segment net sales increased 11.9% to $59.4 million in the third quarter from $53 million in the third quarter in 2008 driven by increases in catalog circulation. Direct segment net sales represented approximately 22% of total net sales in the quarter compared to 23% in the third quarter of 2008. Gross profit for the quarter was $97.1 million or 36.4% of net sales compared to $86.1 million or 37.7% of net sales for the prior year period. The decrease in gross profit rate was primarily due to lower merchandise margins resulting from an increased promotional activity and lower initial markup partially offset by occupancy leverage as a result of higher sales.

As Dennis mentioned we are scaling back our value pricing and are reevaluating our promotional sales strategy and making appropriate adjustments to improve our gross margin. Again, excluding separation agreement costs our selling, general and administrative expenses for the quarter were $102.2 million or 38.3% of net sales compared to $88.8 million or 38.9% of net sales in the third quarter of 2008. The increase of $13.4 million in SG&A expenses was primarily due to increased marketing expenses, increases in wages associated with higher retail sales and other variable costs.

While expense control has been a key priority for the company over the past year we made a decision to increase our catalog circulation and marketing expenses in the third and fourth quarters in order to drive traffic for fall and holiday. Catalog circulation was up approximately 55.1%, higher than our original guidance, due in part to the timing of holiday catalog drops.

Our operating loss in the third quarter was $11.1 million which includes the $6 million in pre-tax charges related to the CEO separation agreement I discussed earlier compared to an operating loss of $2.7 million in the third quarter of 2008. Our adjusted net loss for the three month period ended October 31, 2009 was $3.9 million or $0.04 per share compared to a net loss of $1.3 million or $0.01 per share in the same period a year ago.

I would now like to discuss our balance sheet and liquidity. We maintained a strong balance sheet and liquidity in the quarter and at quarter end cash was at $69.6 million, down slightly from the $72.4 million last year. As a reminder, cash is usually low at the end of the third quarter as we build inventory for holiday.

Working capital was $89.9 million compared to $100.8 million in the third quarter of the prior year with the decrease due to the valuation allowance for the deferred tax assets. We expect to end the fourth quarter in a similar cash position to last year with a meaningful increase in our working capital.

Total inventory increased 12.6% to $193 million compared to $171.4 million at the end of the third quarter of fiscal 2008, slightly lower than our 16.7% increase in sales for the quarter. Our retail square footage increased 4.9%. Premium retail inventory including the retail inventory in the distribution center decreased 7% per square foot compared to the third quarter of last year. We transferred our clearance inventory from our premium retail stores to our outlet and website a week earlier last year due to our decision to start holiday in late October this year. If we had moved our inventory to our distribution channel in November consistent with prior years and our original expectation, our premium retail inventory per square foot would have been up 6% year-over-year at the end of the quarter.

We expect inventory to be up approximately 20% per square foot at the end of the fourth quarter. However, approximately five percentage points of this increase is related to changes in the timing of our flow strategy and bringing in our spring [receives] earlier than last year.

Capital expenditures for the third quarter totaled $5.2 million as compared to $23.2 million a year ago, primarily related to new stores and IT investments. To date we have opened all 10 of our new stores planned in fiscal 2009. We expect capital expenditures to approximate $25 million for the full fiscal year 2009 which is down significantly from fiscal 2008 as a result of reduced new store growth plans and lower technology investments.

Depreciation and amortization including stock based compensation was $19 million for the third quarter of fiscal 2009 and we continue to expect depreciation and amortization to be approximately $70 million for the full year.

With that I will turn the call back over to Dennis.

Dennis Pence

Thank you Tim. Now I would like spend a few minutes discussing our outlook. While it is still very early, during the month of November we have experienced comparable store sales at a run rate consistent with the third quarter. However, the majority of the holiday season lay ahead and while we believe our new sales strategy after Christmas will improve the productivity of our sale, the impact of value pricing and intensified promotional activity that was already planned is expected to again negatively impact our fourth quarter product margins and operating performance.

That said, while we currently anticipate a loss in the fourth quarter we expect a substantial improvement over our prior year results. We anticipate the benefit from changes to our pricing and promotional cadence to be reflected in our 2010 performance beginning in Q1.

In closing, I would like to take this opportunity thank Tim for his many contributions over the last three years. He has assisted us in navigating through an extremely challenging environment with integrity and dedication. I wish Tim all the best in his new position. We have initiated a search for a new CFO and in the interim have appointed our general counsel, John Hayes, to serve as CFO until a replacement is found.

John began his career as a CPA and has been practicing securities law for the past 17 years. He has been working with the Creek for over nine years as our outside counsel. Prior to joining the company earlier this year and he is with us on the call today. Now I would like to open the call to your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Neely Tamminga - Piper Jaffray.

Neely Tamminga - Piper Jaffray

In terms of the gross margin I am just wondering how in Q4 it sounds like you are looking for the product margins to actually be worse but if memory serves the product margin was really, really bad in Q4 last year. So if you could just remind us where the out the door merchandise margin was relative to gross margin in Q4 and maybe help us reconcile how that is in comparison with Q3? More on that would be helpful. Then in addition, if you could talk a little bit about your marketing expense for Q4, what your expectations are going to be particularly calling out SG&A dollar growth in view of the mid teen increase that you seem to be tracking in November comps?

Tim Martin

I will take the first one. I think actually to be a little more clear we actually expect product margins on a year-over-year basis in the fourth quarter will actually be improved.

Neely Tamminga - Piper Jaffray

Can you maybe again hit on the historical context of what was clearly a tough compare in Q4 last year.

Tim Martin

I don’t want to get into specific guidance as to what we are expecting on a margin level component but we do expect a meaningful improvement over last year’s numbers. We think we have opportunity to deliver that even in light of the promotional and sales discussions we have talked about.

Neely Tamminga - Piper Jaffray

So you are looking for gross margin, not just merchandise margins to actually be up on a rate basis year-over-year and meaningfully?

Tim Martin

That is correct.

Neely Tamminga - Piper Jaffray

Squaring that, if you are running double digit positive comps and obviously you may not be planning to that level but given that trajectory and then gross margins being up significantly year-over-year on a rate basis, is the delta then SG&A as to why you would be losing money in Q4?

Tim Martin

You said it best at the beginning of this question in that last year gross margin rates were very low. Even with an improvement you still have a challenge to reach that profitability level with these current run rates. SG&A to answer your earlier question overall we are expecting to be down on a year-over-year basis.

Neely Tamminga - Piper Jaffray

In dollars?

Tim Martin

In dollars. Specifically our marketing will be slightly up within $1-2 million versus prior year versus our current expectations. Versus our current expectations. Then that is consistent with what we guided to at the end of the second as well.

Neely Tamminga - Piper Jaffray

In terms of I just want to make sure I am packing this value pricing concern, issue or change or strategy change correctly. Is it that the consumer responded so well to value pricing in that the conversion rate on the promotion with the $30 off a $100 purchase was on top of value pricing consistently more so than you were anticipating? Clearly you had a view as to what the percentage of penetration of your value pricing product was going to be or was it just that the overall preference for value pricing versus non-value pricing was far greater than you were expecting? Help this lay girl understand that a little bit on the retail end.

Dennis Pence

I think quite clearly the combination of the two was so meaningful that it created an overall deterioration. When we use the term value pricing I think it is important to recognize that as we look at the overall assortment and I am looking at it with a fresh pair of eyes, having been gone for a long time, as you look at the overall assortment vis a vie our peers, we are really not receiving value for the quality of the merchandise in terms of our going at retail prices. That certainly is having a boat anchor effect.

We did also see, to your point, that some of our most aggressively priced items when combined to a greater extent than anticipated with the promotional cadence that had already been put in place with the catalogs already printed, really drove really great traffic at very, very low margins. Your quarter was exacerbated very much by the last few weeks of the quarter and really the October sale which last the entire month of October and was scheduled even to last the first week of November originally. So 5 full weeks is really a two part sale. The first part which has been the tradition here in the last 2-3 years, is a lesser mark downs that are signed and the second part is deeper discounts with a second series of marks. What we found was the expected sales coming at the first mark down rate was significantly less than anticipated, forcing a much higher percentage of the inventory that was cleared to be cleared at deeper discounts than anticipated.

I would say that was the single largest contributing factor to the miss this quarter.

Neely Tamminga - Piper Jaffray

You have been pretty good about characterizing your next quarter’s outlook relative to the prior quarter. Would you expect the loss for Q4 to be less of a loss than that which we just experienced in Q3?

Dennis Pence

Of course I don’t think given we haven’t even hit Thanksgiving my crystal ball is clear enough to really say obviously. I just can’t hypothecate. Sorry.

Operator

The next question comes from the line of Chris Kim - JP Morgan.

Chris Kim - JP Morgan

Could you clarify kind of the timing and the flow of the pull back of promotional pricing in the fourth quarter? Is it post-Thanksgiving?

Dennis Pence

No, the promotional pricing has already been pretty much set in stone in terms of we use our catalogs which of course have been printed to really send that promotional pricing message out. The goods have already been ticketed with the current pricing and those promotions had already been printed prior to us seeing the whites of our eyes the second half of October. So you are looking at something where we really began to see a turnaround in terms of the pricing margins, as I indicated, beginning in Q1.

Chris Kim - JP Morgan

What you are saying is the depth and breadth of the second and third mark downs will…

Dennis Pence

We do hope, although this is the first time utilizing this strategy, we do hope and anticipate we will have a stronger post-Christmas sale period than the October sale period. We realized better results overall for the entire period of sales. We will be on sale a shorter period of time than we did last year and a shorter period of time than our October sale. So quite correct, we have already begun to make the changes in regards to that piece of the pricing component that is broken and that is how we handle sales.

Chris Kim - JP Morgan

Also in terms of margin, can you talk about some of the opportunity as it relates to the alignment of the sourcing efforts around this pricing strategy? As I understand it, it had a relatively large adverse impact in the second and third quarters. When do you think it could become a little more aligned, I suppose?

Georgia Shonk-Simmons

We will be more aligned starting in the first quarter. We have moved quickly both in our negotiations and also with how we are looking at the new strategy at retail prices. You will see increases there and then you will see a larger increase for the gross margin for summer. So we have rolled very quickly and we will continue to do this as we move forward.

Operator

The next question comes from the line of Liz Dunn - Thomas Weisel Partners.

Liz Dunn - Thomas Weisel Partners

Could you talk about how comps trended through the quarter and related to some of your comments about gross margin? What would have happened if you had decided not to see this sale in October, when it was disappointing, I would imagine you were already running up quite nicely in terms of comp. What was the alternative here? I just want to kind of understand what were you expecting for this quarter because you had given some pretty specific bottom line guidance, for it to be better than the loss you achieved in the second quarter so I think we all came out in the right range a loss of $0.03 to $0.04 consensus was for the third quarter but nobody I think expected this comp including you, I would imagine. I thought that your comp expectation was sort of up single digits and with the little tighter SG&A what were you expecting for gross margin? I am just kind of confused about how this quarter played out.

Dennis Pence

I think I will also let the others speak to that as they wish to the different components. I have to say just from the point of strategy I think there was definitely an effort to push comp as the primary tool to deliver results for third quarter and also I am saying in the fourth quarter. I think a lot of gasoline was thrown on the fire to do that. Obviously it didn’t work out quite as planned. As one looks at it, I think that obviously is a strategy that will not be continued by me. As soon as it can be changed it will be and it will be changed beginning at the end of the holiday season.

But I think the main thing that I am looking at is the opportunity still to look at improving comps on a go-forward basis but I think we have great opportunity not only in regard to value pricing but in terms of our IMUs in general. We are seeing through delivered comparisons with our competitors, significant opportunities in pricing and we have begun a methodical testing of higher pricing in selected groups of stores category by category. While it is certainly premature to speculate on the financial implications of that going forward the initial ramifications are that we simply internally did not respect the quality of the product we were delivering to the customers. That was reflected in what we were asking for the product.

Liz Dunn - Thomas Weisel Partners

Can you speak to how the comp trended through the quarter? Also weren’t you supposed to source into some of these lower prices? What happened with that?

Georgia Shonk-Simmons

We did. Our comps were lower. There is no question. If you look at what happened was the velocity of people taking our promotional activity and adding in on top of the value pricing it was greater than we expected. So really in the first two thirds of the quarter the comp was high and then again October was really the issue that we fell apart with the sales cadence. Again, based on our sales testing also if we had to do it over again we would have shortened that sale and just went onto the higher mark down velocity. We could have helped ourselves. We have been on this road of having our sale period, as Dennis alluded to, where we start with a lower and then go to a higher. They go 4-5 weeks. We have done some testing there that says we don’t have to be on sale that long. We can move through the goods.

Dennis Pence

I think the good news in terms of comp is the response of the customer to the product itself is strong. In regards to your question about trending and comp, we saw it in August. We saw it in September and we are seeing it again in November now that we are off sale again. So that has been consistent and I think it is a reflection that the assortment, the basic assortment itself, is now back on track.

I think the pricing issues, the marketing issues in regard to the amount of promotional activity is a lot easier in my point of view to fix than the assortment that is not compelling to the customer.

Operator

The next question comes from the line of Liz Pierce - Roth Capital Partners.

Liz Pierce - Roth Capital Partners

Kind of just getting onto the exact point you said, if I understand this correctly the value pricing you believe that if the price had been different you still would have been able to sell those products? Like if you had raised the price $20 or $30?

Dennis Pence

Obviously what one believes and what one knows with absolute certainty is two different things. Based on the initial testing which I have initiated and as you know I am a big believer in test, test, test, test, the initial testing which I had initiated starting a few weeks ago, we are seeing that in key categories and the tests of course are yet premature to talk about on a roll out basis but we are seeing in key categories that units go down, sales dollars remain the same and margin dollars were up substantially. It seems to be a much better way to run the route.

We have seen that now in two major categories. We have also begun back testing, looking at rolling a group of stores in a certain category and holding out a second group of stores with the original lower pricing and we are seeing that work. While we obviously have a lot of opportunity and I am certainly not happy with the results we are talking about this quarter; I am very, very disappointed. It seems to be that we also have an incredibly clear path to fixing this in a very, very quick way.

Liz Pierce - Roth Capital Partners

I guess my thought is that these seem to be issues and I don’t want to say they are easy to fix, but to your point aren’t they a lot easier than restructuring and refocusing or whatever on product? It seems like the product is selling.

Dennis Pence

Absolutely. I think that a key also which I alluded to in my remarks, we now have one chief merchandising officer. She has had a great track record over the years for our investors. Many of us have benefited because of that and she is again fully in charge of the merchandising strategy. So we need to see what she does for us next year.

Liz Pierce - Roth Capital Partners

On the value pricing, I don’t think I am quite clear on the direction. It sounds like it is going to be a good/better/best?

Dennis Pence

Good/better/best will always continue to be a strategy that I think is just embedded in what we should be doing given the size of the stores and the capability of having a Good/better/best assortment. I think value pricing should correctly be targeted to a specific, very small number of products that are predetermined that are bought and negotiated so it doesn’t squeeze our margins and enough volume so that key items act as traffic drivers, really door busters, to really help increase the volume just as a $1 off promotion would be used on another week. We are going to be reiterating value pricing that way very quickly but that will be a very small percentage of the assortment.

Liz Pierce - Roth Capital Partners

What percentage was the value pricing?

Georgia Shonk-Simmons

Actually, when we look at the value pricing it was about 30% of the assortment. So in the gift giving time that is a lot of SKUs and a lot of pieces to the assortment.

Liz Pierce - Roth Capital Partners

30% in Q3?

Georgia Shonk-Simmons

Yes.

Liz Pierce - Roth Capital Partners

If I understand what you said correctly then the reason you can’t do anything for the fourth quarter is that the books have been mailed, the product has been ticketed?

Dennis Pence

To put it succinctly we are in the fourth quarter.

Liz Pierce - Roth Capital Partners

But you had to know on the value pricing some time, when did it first become obvious that this was going to have somewhat of an impact on margins?

Dennis Pence

Well we were seeing all the way through but we really thought given the strong October sale we could still deliver results that people would be satisfied with. I felt there was going to be a disconnect in the strategy between the phenomenal comp obviously, the results that would have been driven, but there could have been some I think understanding about that. I think when the October sale results were what they were that further exacerbated the situation and is causing I think the puzzlement that I am hearing from the people on the call and I have to say rightfully so.

Liz Pierce - Roth Capital Partners

So your strategy for the sale post-Christmas is you will take a deeper first mark down?

Dennis Pence

First mark down, best mark down and then get back to full price goods much sooner.

Liz Pierce - Roth Capital Partners

And you are going to shorten the time frame?

Dennis Pence

Three weeks.

Liz Pierce - Roth Capital Partners

It was five weeks last year?

Dennis Pence

I’m sorry. I just heard Tim validate. It was six weeks last year. I wasn’t aware.

Liz Pierce - Roth Capital Partners

Georgia, on the sourcing, how much of a restart is this on some of the sourcing initiatives you have been working on or is it not?

Georgia Shonk-Simmons

No, it doesn’t really have anything to do with the sourcing initiatives. It has more to do with how we view the product internally with the quality we are getting. I want sourcing to stay on quite frankly is the fit, quality and added details and uniqueness and get a really, really good price for that but also not leave money on the table because we didn’t put a high enough retail on it.

Dennis Pence

I really want to emphasize no product category retail prices will be taken out without very thorough testing.

Liz Pierce - Roth Capital Partners

Again, it seems to be the heavy lifting in terms of getting the product back on track and getting back to brand attributes. You have done this without lifting and I would presume this is why you think you could have an impact in Q1. It is not like you are telling us another three quarters?

Georgia Shonk-Simmons

I think we have validated easily we believe we are on the right track with the initiatives we took on that work as far as product flow, not necessarily the pricing. So that continues through Q1 and Q2 and more refinement into next year. So comfortable with the strategy as it sits.

Dennis Pence

I will just add as Ronald Reagan once said about the little boy who opened the barn door and saw a large pile of manure. I am looking at it and saying there has got to be a pony in her somewhere. I think I have identified it and I think we are going to have a lot of fun next year.

Operator

The next question comes from the line of Margaret Whitfield – Sterne Agee.

Margaret Whitfield – Sterne Agee

If 30% of the assortment was value in Q3 what Dennis is the more appropriate percentage we can look forward to in the spring? How low did your AURs dive in Q3 and what do you think they could move up to in Q1?

Dennis Pence

You addressed that to me but I think that is more appropriate to Georgia but I would be happy to provide color.

Georgia Shonk-Simmons

So the AUR actually went down really about 20%. That is for the incomplete quarter so that includes the October sales period.

Margaret Whitfield – Sterne Agee

Where do you think it could rise to in Spring of 2010?

Georgia Shonk-Simmons

Spring of 2010, we won’t get it all back initially because again we have raised the margins in some retail but as Dennis said we are testing all the categories we can. I would like to think the AUR would be around 10% and that is how we would hold spring and then hope to be fully back by summer.

Margaret Whitfield – Sterne Agee

What percent of the assortment do you think should be value in spring of 2010 or where will it ultimately go down to?

Dennis Pence

Let me take that. I think there is a great opportunity to have selected items that are targeted as weapons and these items would be targeted as I say to generate a lot of traffic and really help create the momentum that we need next year in what will continue to be a highly promotional recessionary environment. There is no doubt that is continuing.

Margaret Whitfield – Sterne Agee

So well below 30%?

Dennis Pence

Well below 30%. I think single digits would be more appropriate.

Margaret Whitfield – Sterne Agee

The inventory, did I hear inventory per square foot will be up 20% year end and X’ing out spring early deliveries it is more like up 15%? Are you comfortable with that level of inventory?

Georgia Shonk-Simmons

Correct. We are. One of the reasons we have to look at is we are bringing spring in earlier and because sale is going to be shortened we had to buy to a sales plan of more regular price. So actually having a comfort level with where we are. Remember last year at the end of January in January to February we looked like we were going out of business with no inventory. So that was the lowest time we had ever had with inventory. So for us we will be able to fill the stores comfortably; not pack them and still be able to meet the sales plan is the plan.

Margaret Whitfield – Sterne Agee

I think Tim said something about the future tax rate changing. Could you give us some parameters as to what we should model going forward? What did spa do in the quarter and how does Dennis feel about spa at this time?

Tim Martin

For the fourth quarter, I will give you that rate, I would use a mid 30’s rate. Beyond the fourth quarter I am not prepared to talk about at this point in time.

Dennis Pence

I think spa is really just a flea at the moment in terms of it doesn’t really cost us any money in terms of cash, neutral. I wouldn’t want to close them because of the cost of closing stores or the spas. At the same time in this environment I am intensely focused on the core business. We have I believe an enormous opportunity once we fix the core business to potentially grow the core business even more. Relative to our main competitors we are significant under stored. First, I think we have to prove some things to ourselves.

Margaret Whitfield – Sterne Agee

What is the circulation plan for Q4?

Georgia Shonk-Simmons

Circulation plan for Q4 is up about 33%.

Operator

The next question comes from the line of Richard Jaffe - Stifel Nicolaus.

Richard Jaffe - Stifel Nicolaus

Just wondering given the challenges coming out of the sale event this October is there a more timely mark down cadence you could use going forward in spring 2010 or fall 2010 where you are taking lots of little mark downs on a timely basis instead of a seasonal sale event four times a year? Would that give you more nimbleness in being able to avoid this crushing average unit retail depression?

Dennis Pence

If we were to take that idea would you say it is yours if we stole it?

Richard Jaffe - Stifel Nicolaus

No pride of authorship.

Dennis Pence

I think that is a very intelligent direction and something we want to look at in the spring.

Operator

The next question comes from the line of Eric Beder – Brean Murray, Carret & Co.

Eric Beder – Brean Murray, Carret & Co.

Can we talk a little about the tax rate? What is the tax rate going to be going forward now? It would seem to be clearly lower until you have to bring it back again?

Tim Martin

What we are going to say is for the fourth quarter we are expecting it to be around the mid 30’s. Beyond that I am not prepared to talk about guidance for 2010.

Eric Beder – Brean Murray, Carret & Co.

I am trying to get my hands upon the changes here. Is it fair to say the product that worked, worked extremely well and you were able to sell it at a stronger price. The product that didn’t work you had to discount it much more than you expected and that is kind of what happened in Q3. Is that off or is that kind of right?

Dennis Pence

No, I think the first part of your sentence is spot on. I think the second part is as I come back it is obvious that we were beginning to see at the beginning of this year and I think that was talked about by prior management that sale wasn’t working as well. Really I think what we have done is we have trained our very valuable customers to wait for second mark downs. They finally got the message very clearly that there will be a long sale period at Coldwater Creek.

We will try to maximize the margin dollars through the sale period to our benefit and the customer is best served in her eyes now that she has understood that by waiting. We did not then receive the benefit of the first mark sale. So I think the customers had a learned behavior that we exacerbated and I think we simply need to go to the philosophy of giving her the right price to begin with and moving on.

Eric Beder – Brean Murray, Carret & Co.

I guess the question then becomes the next sale period, beyond this there might be less sale product. How are you going to talk to the customer and convince them they need to buy it at the first cut and that is the only cut. Is it very visible and obvious for the customer to notice?

Dennis Pence

I think one of the things we can do is indicate the timing of the sales and so indicate the length of the sale and that will give her a real expectation that only so many days remain and continue to express that message. We have considered that and certainly I think that is a very valid point and part of the marketing strategy needs to take that into account. If indeed this is a learned response then we need to indicate to her we are going to take it in a different way.

Operator

The next question comes from the line of Analyst for Roxanne Meyer – UBS.

Analyst for Roxanne Meyer - UBS

Can you give us a sense of what percentage of sales came from clearance? How this compares to the historical norm? Then just looking for more color on your strategy to improve the direct business. You already mentioned you are going to increase circulation and have more personalized contact with the customer.

Tim Martin

The first one is we don’t break out our cost sales and mark down and segregate out our sales like that. I apologize.

Dennis Pence

In the second one there is a lot of opportunity as we come back in. We see in the internet business that a lot of our traditional internet business has been driven by our catalogs when we significantly reduced the number of catalog mailings significantly of course affected our internet business. We have been late to the party in terms of things like Facebook, all those marketing initiatives. We need to start moving on those types of initiatives very quickly. I think the opportunity for mailing more frequently but not over mailing. Now the circ was way up this last quarter and we need to be very thoughtful about who we mail the catalogs to in order to try and ensure that we don’t waste precious marketing dollars.

The better customers will take more frequent mailings and we have already put a plan in place next year to do that but in a way where we get leverage on those SG&A dollars on the top line as opposed to just increasing circulation. So that is two ways we are going to do it.

Operator

The next question comes from the line of Liz Pierce - Roth Capital Partners.

Liz Pierce - Roth Capital Partners

To clarify what you said about just one merchant, can you just maybe go over where there were some changes?

Dennis Pence

I think that quite obviously Georgia has had a very long and successful career here. I just want to emphasize I don’t see myself as a chief merchant. My responsibility is to drive the overall profitability of the company. So that is what I mean.

Liz Pierce - Roth Capital Partners

So not that there has been perhaps some higher level changes under Georgia?

Dennis Pence

No. I didn’t mean that at all.

Liz Pierce - Roth Capital Partners

So Georgia and your team is pretty much in place as it was?

Georgia Shonk-Simmons

Absolutely.

Liz Pierce - Roth Capital Partners

A final question on the timing of the holiday drop, you said the circ was up 55.1%?

Dennis Pence

Georgia said that.

Liz Pierce - Roth Capital Partners

How did that compare, the timing of it with last year?

Georgia Shonk-Simmons

Q3 was up 55%. Of that 40% of that circulation was fall and 15% was holiday moved up.

Liz Pierce - Roth Capital Partners

That was moved up because?

Georgia Shonk-Simmons

It was just the flow of the goods and how we were planning holiday this year.

Liz Pierce - Roth Capital Partners

As we think about the post-Christmas clearance being shorter this year when will we start to see that spring product land in stores? About when?

Georgia Shonk-Simmons

You will see it land in stores the second week of January. Actually maybe three weeks earlier than prior year.

Liz Pierce - Roth Capital Partners

Three weeks before [OY]?

Georgia Shonk-Simmons

Yes.

Liz Pierce - Roth Capital Partners

With that you think there is sufficient time over the next 4-5 weeks to work on this value pricing?

Georgia Shonk-Simmons

Yes. We have been actually analyzing this for awhile now and quickly moving on the things we could and testing some categories already. So we saw some other categories to test that we can still affect summer but we have definitely affected some of the categories for spring.

Liz Pierce - Roth Capital Partners

I wanted to also ask on the denim, cords and knit jeans, you felt just on the traditional denim you were over-assorted?

Georgia Shonk-Simmons

Yes. I think our newness was very well accepted but I think in our traditional denim we just had too many colors and too many washes. Overall the assortment was too large in denim. So we are going to make it much more efficient, effective and easier for her to shop going forward.

Liz Pierce - Roth Capital Partners

On the blouses, on the woven, the more dressier stuff?

Georgia Shonk-Simmons

Listen, I think two things happened there. I think the first thing is that it is a season of knits. Certainly our woven shirts business is good but our knit business is extraordinarily strong so I think that becomes the replacement as a layering piece. Secondly, I think our blouses were too dressy. Too many ruffles and fabrics too soft and therefore we were just not…we are going to be very judicious in how we handle that category going forward.

Liz Pierce - Roth Capital Partners

Do you envision for Spring that dresses and skirts will be a meaningful part of the assortment?

Georgia Shonk-Simmons

Yes. Certainly skirts will be a meaningful part of the assortment later in the spring. Not necessarily in January. Then you will see dresses pop up certainly much more so on the West and then summer is an explosion of skirts and dresses.

Liz Pierce - Roth Capital Partners

It seems to be on your skirt silhouettes that they don’t seem as much fabric. A little bit shorter hem length?

Georgia Shonk-Simmons

We have absolutely…because of our customer research we have shortened the hem length. We are also doing some success with some fashion slimmer skirts. We are taking from that and moving forward. Of course summer and spring the skirts get a little bigger and more flowy. But we will still be considering some short pencil skirts.

Dennis Pence

IN all this discussion which I think is rightful for everyone to focus on and absolutely appropriate, we haven’t really commented on the success of the fit and size initiative which I know management was talking about earlier in the year. We definitely saw that the new fit of the jackets and silhouettes was a huge hit with our customers this September when they were introduced. We feel that is a significant improvement. It also makes the assortment much more contemporary in terms of its outlook to the younger part of our established target demographics.

So I am very, very pleased with that. I think everybody involved in the fit initiative did a great job.

Liz Pierce - Roth Capital Partners

On the accessories, particularly the jewelry, if you could just give us an update. I definitely noticed some improvement and was curious where you felt it stood in terms of what you could do with it.

Georgia Shonk-Simmons

I still think we have seen improvement. We are happy with that. We have a long way to go and actually have some really exciting things coming up for you this year in jewelry. I think the accessories business will continue to be strong. Scarves are really important. We will see again moving in that direction and really trying to increase that business.

Operator

Ladies and gentlemen there are no further questions at this time. I would like to turn the floor back to management for closing remarks.

Dennis Pence

Finally, thank you one and all. I wish everyone a happy Thanksgiving. We will be back in touch next time.

Operator

Thank you. Ladies and gentlemen this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Coldwater Creek, Inc. Q3 2009 (Qtr End 10/31/09) Earnings Call Transcript
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